Pomerantz LLP

The SEC’s Recent Approach To Cryptocurrency


At first glance, the U.S. Securities and Exchange Com­mission (the “SEC”) has had a reserved and seemingly inconsistent approach to cryptocurrency, at times stepping into the fray for enforcement actions against a particular cryptocurrency it deems a security, but often staying out of the picture and refusing to provide detailed guidance. Although this leaves much to be desired, with many open questions about how defrauded prospective plaintiffs could proceed themselves, the few decisions the SEC has made reveal a lot.  

The Threshold Question: Is it a Security?  

Despite many commentators describing an uncertain ap­proach, the SEC has given a fairly clear test for when it will treat cryptocurrencies as securities and subject them to the onerous rules that come with the classification. Important­ly, on June 4th, 2019, the SEC sued Kik Interactive, Inc. in relation to its sale of the digital token Kin without regis­tration. The SEC claimed it was a security because Kik’s marketing presented it as an investment that would reap profits from Kik’s efforts, and met the traditional Howey test for investment contracts. The SEC treated another Initial Coin Offering (“ICO”) very differently. In the earlier case of Turnkey Jet, Inc.’s ICO of TKJ digital coins, the SEC issued its first no-action letter in this sphere on April 3, 2019. It deemed TKJ not a security, because the marketing did not hold it out as an investment opportunity with an expecta­tion of profits from the company’s efforts to develop the digital infrastructure around the coin. The key component was that the coin was to be used only for buying charters, and the digital platform was already established, rather than part of an ongoing project that coin purchasers were buying themselves into to reap potential profits if and when it was successful, in contrast to Kik and their ICO of Kin. This clearly shows how TKJ was more like a currency, to be used for its function, while Kin was an investment se­curity, and not being sold or purchased for its utility as a digital currency. Kik made statements about how its coin would increase in value due to its efforts to further develop the platform, while TKJ cautiously crafted its marketing to not take on any characteristics of a security.  

These two examples offer guidance to prospective of­ferors of ICOs on how to avoid securities treatment, and importantly, to prospective class action securities plaintiffs attempting to convince courts that a digital coin at the heart of their suit is a security.  

To recover for securities fraud when a cryptocurrency is involved, the threshold question will always be whether the digital tokens or coins are a security in the first place. The SEC guidance, the “Framework for ‘Investment Contract’ Analysis of Digital Assets,” provides a host of factors for whether a cryptocurrency will be regulated as a security. With the Howey test as a background, The SEC defines these factors to include: purchasers’ expectation of profit from the efforts of the issuer of the coin; whether a mar­ket is being made for the coin; whether the issuer is ex­ercising centralized control over the network on which the coins are to be traded; the extent of the development of the blockchain ledger network, whether the coins are to be held simply for speculation or are to be put to a specific use; prospects for appreciation, and use as currency. This undergirds an important dichotomy that has emerged be­tween the Existing Platform and the Developing Platform. If a cryptocurrency has a blockchain distributed ledger platform already created before money is raised through an ICO, and is run by a distributed network, then it is not likely to be defined as a security, whereas if the platform is still under development and under the management of the issuer at the time the coins are offered to the public, and is created and/or developed with the money raised in the ICO, which boosts the value afterwards, it is likely to be defined as an investment security.  

Investors and the Role of Class Actions  

Given the lucrative growth, volatility, and sometimes rapid declines we have seen in cryptocurrency values over the past few years, many have treated cryptocurrency as an investment, and many have suffered great losses. Crypto­currencies, even if not on public stock exchanges, are trad­ed with the same ease and appeal to unsophisticated retail investors as stock for Apple and Walmart. They are readily available on Coinbase, Binance, and other popular web­sites and apps, and a host of individuals and companies have begun releasing their own peculiar coins. Importantly, the novelty and ease of access to retail investors makes the cryptocurrency world one ripe for deceit and fraud, especially for the multitude of very volatile coins that are treated the same as securities by purchasers. As an illus­tration, users on Coinbase follow a chart with daily, weekly, monthly, and yearly curves showing the price movements of various digital currencies, and many treat it no differently than they would their E-trade account. Thus, this is a situ­ation where securities class actions should take on a big role, as they are often the chief vehicles to defend the kind of diffuse harm to ordinary investors that is likely to take place with these digital coins.  

Furthermore, due to the exponential growth of money held in cryptocurrencies, institutional investors are also follow­ing suit and adding them to their portfolios. According to a study released by Fidelity Investments, around half of institutional investors believe digital assets are appropriate for their portfolios.  

In Balestra v. ATBCOIN, the proposed plaintiff class sur­vived dismissal on the threshold question. The Judge found all the elements of a security met on the facts as alleged, finding that the ICO intended to raise capital to create the blockchain, and that efforts to do so by ATB would increase the value of the investment if successful. In the case of Rensel v. Centra Tech, purchasers of coins in a $32 million ICO are attempting to certify a class in their securities fraud suit. The company is already facing crim­inal and SEC enforcement actions for its allegedly false and misleading statements about licensing agreements it claimed to have with major credit card companies, and other alleged falsehoods. One of the main points that the proposed class focus on in their motion is whether the CTR tokens are investment contract securities, and they are trying to use the Howey test to make arguments sim­ilar to those used by the SEC against KIK: that investors in CTR invested money in the coin with an expectation of profits, there was a common enterprise with no investor control over the coin’s value, and the value was tied to the managerial efforts by Centra Tech and its executives. This threshold question will make or break the case, and whatever the court decides could set important early-stage precedent in this sparsely populated cryptocurrency sub-class of securities class actions. There are also class ac­tions pending against Ripple and Tezos.  

Facebook has recently announced their own new cryp­tocurrency: Libra. The statements the company released about Libra seem to take the prior SEC actions into con­sideration, such as presenting it as a currency with a stable value backed by deposits and low-risk government secu­rities, rather than an investment vehicle. A potential issue stems from an audience Facebook has explicitly stated they will target, namely, those who do not use traditional banks. These individuals are the least sophisticated in financial matters, and the most vulnerable to fraud. While Facebook and others may state that their coins are cur­rencies, they must be monitored diligently to ensure users, especially the most vulnerable, are not purchasing them as an unprotected substitute for the stock market. Securities class actions will be a viable means of protecting such individuals if things go sour with Libra or the many other ICOs already present or likely to hit the market soon.

Facebook Settles With U.S. Agencies


In a press release issued July 24, 2019, the Securities and Exchange Commission announced charges against Facebook, Inc. as well as the settlement of the case; Facebook has agreed to pay $100 million to settle the SEC charges. This comes on the heels of Facebook’s settlement with the Federal Trade Commission (“FTC”), which provided for a record fine of approximately $5 billion arising from the same privacy violations.  

In 2012, the FTC charged Facebook with eight violations regarding privacy concerns, including making misleading or false claims regarding the company’s control of the personal data of their users. The FTC alleged that Face­book had inadequately disclosed its privacy settings that control the release of personal data to third party develop­ers, particularly in instances where one user designated its personal information as private, yet that information was still accessible via a friend who had not so designated it. This, the FTC alleged, dishonored users’ privacy choices; the company settled those 2012 charges by agreeing to an order prohibiting Facebook from making misrepresen­tations regarding the privacy and security of user data and requiring the establishment of a privacy program.  

One of the central allegations of the FTC complaint was that while Facebook announced it was no longer allowing third parties to collect users’ personal data, it continued to allow such collection to continue. Further, the FTC al­leged that Facebook had no screening process for the third parties that received this data.  

The SEC alleged that Facebook knowing misled investors regarding their treatment of purportedly confidential user data for over two years. While the company publicly stated their users’ data “may be improperly accessed, used or disclosed,” Facebook actually knew that a third-party de­veloper had done so. Merely identifying and disclosing potential risks to a company’s business rings hollow when those risk materialize and no disclosure is made.  

According to the SEC’s complaint, Facebook discovered in 2015 that user data for approximately 30 million Americans was collected and misused in connection with political ad­vertising activities. The complaint alleges that Cambridge Analytica, a data analytics company, paid an academic researcher to collect and transfer Facebook data to cre­ate personality profiles for American users, in violation of Facebook’s policy that prohibits developers, including researchers, from selling or transferring its users’ data. The data gathered and transferred to Cambridge Analytica included names, genders, birthdays, and locations, among other pieces of information. This discovery was confirmed to Facebook by those involved in 2016.  

It was during this period that Cambridge Analytica was hired by the Trump campaign to provide data analysis on the American electorate. Touting its cache of some 5,000 data points and personality profiles on every American, Cambridge Analytica assisted the campaign in identifying “persuadable” voters, though it maintains that this anal­ysis was done using data maintained by the Republican National Committee, not by Cambridge Analytica.  Until Facebook disclosed the incident in March of 2018, it continued to mislead investors in SEC filings and through news sources by depicting the risk of privacy violations as merely possible, although they had actually occurred, and by stating that it had found no evidence of wrongdoing, even though it had.  

Compounding the company’s shortcomings was the SEC’s contention that Facebook had “no specific policies or procedures in place to assess the results of their invest-igation for the purposes of making accurate disclosures in Facebook’s public filings.” Had Facebook had such mechanisms in place, the presentation of user data mis­use as a hypothetical risk, when in reality it had occurred, would have been prevented.  

The resolution of this enforcement action by the SEC continues the strong message the agency has been sending regarding the accuracy of public companies’ risk disclosures concerning data privacy and cyber security. This portends to be merely an early round in Facebook’s struggles to bring its business practices under control.

Delaware Supreme Court Grants Investor Request To Inspect Electronic Corporate Record


A recent decision by the Delaware Supreme Court clar­ified that shareholders are potentially entitled to receive emails, text messages, and other electronic records in connection with well-founded books and records requests under certain circumstances. Previously there had been some doubt that produceable “books and records” included those stored in electronic form, with courts often limiting production to hard copy documents actually reviewed by the board. In most cases, traditional, non-electronic documents will likely be sufficient to satisfy a plaintiff’s proper purpose in a books and records action.  

By way of background, many states, including Delaware, allow shareholders to request access to review corporate books and records provided, in general, that the share­holder can articulate a “proper purpose” and that the documents sought are narrowly-tailored and reasonably related to the shareholder’s proper purpose. A share­holder may inspect a corporation’s books and records for any proper purpose rationally related to the stockholder’s “interest as a stockholder.” Commonly accepted proper purposes include valuing a shareholder’s interest in a company and investigating wrongdoing, mismanagement or corporate waste. Shareholders also commonly request books and records in anticipation of serving a litigation demand on a public company.  

A books and records request can be a vital tool for share­holders weighing whether to file a potential shareholder lawsuit. Documents produced in response to a books and records demand can be instrumental in providing addition­al evidence that allows a plaintiff to prevail on a motion to dismiss, by presenting detailed and specific information detailing the alleged wrongdoing and demonstrating that the directors participated in or known about the wrong-doing or otherwise have a conflict of interest. In recent years shareholder plaintiffs have increasingly made use of books and records demands prior to commencing litigation. In particular, the Delaware courts have admon­ished shareholders to use the “tools at hand” and request access to critical books and records prior to commencing certain types of shareholder lawsuits, including share-holder derivative actions and lawsuits challenging mergers and acquisitions.  

In KT4 Partners LLC v. Palantir Techs., Inc., the Delaware Supreme Court reversed a lower court’s decision deny­ing a request for access to certain electronic books and records. The plaintiff’s books and records demand sought to “investigate fraud, mismanagement, abuse, and breach of fiduciary duty” by officers and directors of Palantir. Although the trial court found that the plaintiff had shown a proper purpose, it nonetheless denied the plaintiff’s requests for the production of emails and other electronic documents related to that proper purpose.  

On appeal, the Delaware Supreme Court determined that the Court of Chancery had abused its discretion by “denying wholesale [plaintiff’s] request to inspect emails” related to its proper purpose. In this instance, the plaintiff was able to identify documents that it needed and provided a basis for the court to infer that those documents likely existed in electronic form. The Delaware Supreme Court concluded that Palantir “did not honor traditional corporate formalities … and had acted through email in connection with the same alleged wrongdoing that [plaintiff] was seeking to investigate.” Making matters worse, Palantir, faced with plaintiff’s allegations, failed to present any evidence of its own that more traditional materials, such as board resolutions or minutes, even existed, much less would satisfy plaintiff’s need to investigate its proper purpose. Thus, the court took the unusual step of order­ing the production of emails in addition to more traditional corporate books and records.  

A clear takeaway from the court’s decision is that, if a company elects to conduct business through electronic communications, it assumes the risk that these electronic communications may be the subject of a books and records demand. To this end, the court noted that a company “cannot use its own choice of medium to keep stock-holders in the dark about the substantive information to which [the Delaware books and records statute] entitles them.” Conversely, where a company is careful to conduct all of its official business through more traditional channels, a plaintiff will likely have more difficulty demon­strating its need to access electronic commu­nications and electronic documents in a books and records action.  

Following the reasoning of the KT4 decision, the Delaware Chancery Court recently ordered the production of electronic communication in a books and records action against Facebook involving data privacy breaches. Among other categories of documents, the plaintiffs in that action sought “electronic communications, if coming from, directed to or copied to a member of the Board,” regarding the alleged misconduct. There, the court found that “[p]laintiffs have presented evidence that [Facebook] Board members were not saving their [hardcopy] communica­tions regarding data privacy issues for the boardroom.” Limiting its production to hard copy documents, Facebook produced only a compilation of highly redacted Board minutes that contain “essentially no information regarding the relevant subject.” Accordingly, the court in that instance granted in part plaintiffs’ request to produce electronic communications, even though Facebook ad-hered to many “traditional corporate formalities” which Palantir did not.  

Read together, KT4 and Facebook indicate that Delaware courts are beginning to take a more contemporary, real world approach in considering whether the production of electronic communications are necessary to satisfy a plaintiff’s proper purpose in a books and records actions. Where plaintiffs are able to present evidence that a compa­ny utilizes electronic communications in conducting official business, they will be able to present stronger arguments in favor of the production of electronic communications in books and records actions and, in the process, potentially secure the production of evidence which may, in turn, be critical in building a case at the early stages of litigation. Given the crucial role played by electronic communications in most business transactions, it is likely that production of such documents will be far more commonplace in future books and records cases.

Second Circuit Again Considers “Price Maintenance Theory” In Securities Class Actions


On June 26, 2019, the Second Circuit heard oral argument on the defendants’ appeal of the district court’s class certification order in Arkansas Teacher Retirement System v. Goldman Sachs Group, Inc. (“ATRS”). The panel’s decision could provide guidance on how district courts should apply the Supreme Court’s decision concerning the “fraud on the market” presumption of reliance in securities fraud class actions involving the so-called price maintenance theory. This theory asserts that defendants’ fraud did not inflate the price of the company’s stock but, rather, prevented it from falling by misrepresenting or concealing bad news.  

Demonstrating that the critical issue of investor reliance can be established on a class wide basis has always been a crucial issue in securities litigation. In Basic v. Levinson, the Supreme Court held that in securities class actions involving stock traded on “efficient markets”, courts may presume that investors all relied on “the integrity of the price set by the market,” and that fraudulent statements would have distorted the market price. In Halliburton Co. v. Erica P. John Fund, Inc. (“Halliburton II”), the Supreme Court held that defendants can rebut the presumption by showing “that the asserted misrepresentation (or its correction) “did not affect the market price of the defendant’s stock” because it was not “reflected in the market price at the time of [the investor’s] transaction.”  

The simplest and most straightforward evidence of price impact is a misstatement quickly followed by an increase in the market price. Sometimes, however, plaintiffs try to demonstrate price impact by showing that the statement in question “maintain[ed] the inflation that is already present in a security’s price.” In other words, under this “price maintenance” theory, price impact is shown where a mis­statement maintains that security’s artificially inflated price.  

The Supreme Court’s decision in Halliburton II did not address several issues concerning the fraud-on-the-market presumption, including how defendants can rebut plaintiffs’ showing of price impact in cases alleging price maintenance. The Second Circuit panel in ATRS, however, squarely raises these issues.  

ATRS arose out of losses incurred by investors in four collateralized debt obligations issued by Goldman Sachs (the “Goldman CDOs”). The Goldman CDOs in 2006 and 2007, shortly before the 2008 financial crisis, without disclosing that the CDOs were designed so that a Goldman hedge fund client, or Goldman itself, could reap billions in profits when the assets underlying the CDOs failed.  

Plaintiffs, purchasers of Goldman common stock, filed a class action against Goldman and certain of its officers and directors alleging that they had made material misstatements and omissions regarding the conflicts of interest attendant to the Goldman CDOs, which harmed investors in Goldman’s stock when the stock price declined after the conflicts of interest were disclosed. According to plaintiffs, while Goldman was marketing the CDOs to its clients, it was filing 10-Ks with the SEC and releasing annual reports assuring investors that the firm had “ex­tensive procedures and controls that are designed to identify and address conflicts of interest.” Plaintiffs alleged that these and other statements were revealed to be false when the press reported that (i) the SEC had filed a civil lawsuit charging Goldman with securities fraud in connection with one CDO, (ii) the United States Department of Justice had opened a criminal investigation into whether Goldman had committed secu­rities fraud in connection with its mortgage trading and (iii) the SEC had opened an investigation into a second CDO.  

After the court rejected defendants’ motion to dismiss the complaint, the ATRS plaintiffs then moved to certify a class of all purchasers of Goldman common stock during the relevant period. Defendants opposed class certification on the grounds that plaintiffs had failed to demonstrate “price impact.” Specifically, defendants submitted declara­tions and affidavits saying that Goldman’s stock did not increase on the dates that the 10-Ks and annual reports containing the alleged misrepresentations were dissem­inated, nor had the price of Goldman’s stock decreased on 34 days before 2010 when the press had previously reported the conflicts of interest concerning the Goldman CDOs. Goldman’s stock did, however, decline significantly after the disclosures that the government was investigating and suing Goldman over its role in issuing and underwrit­ing these CDOs.  


The district court rejected defendants’ arguments and cer­tified the class, holding that defendants had not provided “conclusive evidence that no link exists between the price decline [of Goldman stock] and the misrepresentation[s]” (emphasis added). Among other things, the Court held that it could not consider defendants’ arguments that Gold­man’s stock price had not increased on the dates of the alleged misstatements or decreased on dates of press reports regarding Goldman’s alleged conflicts of interest in connection with the Goldman CDOs because, the court said, “truth on the market” and materiality defenses were not appropriate to consider at the class certification stage.  

While defendants’ appeal to the Second Circuit was pending, a different Second Circuit panel ruled in Waggoner v. Barclays plc (“Barclays”), where the investor class was represented by Pomerantz LLP. The Barclays panel held that when opposing a motion to certify a class in a securities fraud action, a defendant can rebut a purported showing of price impact by demonstrating by a preponderance of the evidence that an alleged misrepresentation had no effect on the price of the security at issue. While Barclays was a significant victory for investors, the “preponderance of the evidence” burden it seemed to be placing on de­fendants to rebut price impact was less onerous than the “conclusive evidence” required by the district court in the ATRS case.  

Citing Barclays, the Second Circuit reversed the district court’s certification of the ATRS class because it was unclear whether the district court had applied Barclays’ “preponderance of the evidence” standard. On remand, the ATRS Plaintiffs relied on a declaration and testimony from an expert who concluded that the declines in Goldman’s share price after disclosure of the government’s actions against Goldman were at least in part attributable to the revelation that defendants had made misstatements con­cerning Goldman’s conflicts of interest, commitment to its clients and compliance with governing laws Defendants countered with expert reports and testimony that purport­ed to show that the alleged misrepresentations had no effect on Goldman’s stock price because plaintiffs’ expert testimony was unreliable and incomplete, and Goldman’s stock price did not decline on 36 different days prior to 2010 when the press published articles concerning alleged conflicts of interest with regard to the Goldman CDOs.  

The district court rejected defendants’ arguments and re-certified the class. The court first held that plaintiffs’ expert had established a link between the reports of Goldman’s conflicts and the subsequent declines in Goldman’s share price. It then held that defendants’ evidence that Goldman’s stock price had not declined on 36 days prior to 2010 did not rebut plaintiffs’ showing because “[t]he absence of price movement . . . in and of itself, is not sufficient to sever the link between the first corrective disclosure and the sub­sequent stock price drop.” Finally, the district court held that defendants’ arguments that the alleged misstatements could not have affected Goldman’s stock price because those statements were immaterial was not appropriate to consider at the class certification stage.  

Defendants appealed again, arguing, among other things, that the district court had erred in applying price mainte­nance theory. They argued once again that there was no evidence that Goldman’s stock price was ever “inflated” by defendants’ alleged fraud, and that the district court had never addressed whether there was inflation “already extant” in Goldman’s stock price at the time the alleged misstatements were made. Defendants also argued that the alleged misstatements “were not the types of statements that courts have recognized as capable of maintaining in­flation in a public company’s stock price.” Finally, Goldman argued that the alleged misstatements were “so general that a reasonable investor would not rely on” them and thus the statements could not “inflate or maintain a stock price.”  

Plaintiffs responded that “[t]his Court and others have re­peatedly rejected Goldman’s claim that price-maintenance is limited to cases involving ‘fraud-induced’ inflation” and “[the Second Circuit] rejected [Defendants’] attempt to defeat class certification on materiality grounds in the last appeal.”  


The Second Circuit panel hearing this second appeal in ATRS has the opportunity to provide much-needed guid­ance on plaintiffs’ use of price maintenance theory. The most important issues on the table are whether a plaintiff has to establish that there was fraud-induced price inflation of the company’s stock before the misrepresenta­tions were made. Suppose, for example, that a company’s previous financial disclosures had been accurate, but then profits had declined but the company falsely claimed that profits had not declined, preventing the stock price from falling. Does that pattern of behavior not satisfy the re­quirements of price maintenance theory? The case also raises the question of whether price declines following disclosures of the negative information are enough to support “price impact” claims even if the price had not declined in other instances following disclosure of similar information.  

The appeal also raises the issue of whether, as defen­dants contend, the panel should limit price maintenance theory to circumstances “where specific statements . . . (i) offset investor concerns or (ii) confirm[] market expectations, in either case about a material financial metric, product, or event.” If the panel rejects this argument, it would clarify that price maintenance theory applies to misstate-ments that, when corrected, revealed no concrete financial or operational information that had been hidden from the market for the purpose of maintaining the stock price, as well as misstatements whose materiality is in question.  

Finally, the panel’s decision could address a potential ambiguity in the Goldman I decision concerning whether the materiality of the alleged misrepresentations should be considered on a class certification motion.

Plantiffs' Attorneys and "Blow Provisions": An Uneasy Coexistence



During a settlement hearing on June 18 in the matter of In re RH, Inc. Securities Litigation, U.S. District Judge Yvonne Gonzalez Rogers of the Northern District of California took plaintiffs’ and defendants’ counsel to task for failing to disclose the existence of a confidential side deal between the parties. By all indications, the agreement in question related to a so-called “blow” or “blow-up” provision. Blow provisions provide settling defendants with an option to terminate the settlement agreement if a specified threshold of investors elect to exclude themselves (or “opt out”) of the settlement. Opt-out thresholds can be pegged to the dollar amount of the defendants’ potential exposure to opt outs, the per­centage of the shares purchased by class members, the percentage of shares outstanding, or the percentage of shares traded. From a settling defendants’ standpoint, the rationale is obvious: if too many class members opt out of the settlement, those same class members are likely to pursue their own cases against the defendants based on the same underlying conduct alleged in the class action. This makes the value of the class action settlement far less attractive to the defendants. No one wants to pay millions to settle a class action, only to be subjected to massive subsequent claims from investors who have opted out of the class. Where a defendant cannot sufficiently minimize its liability exposure in potential post-settlement “opt out” cases, settlement of the class action becomes a significantly less palatable proposition. The catch, as it were, is that the presence of an exces­sive number of opt-outs cannot and will not be known until the settlement has been inked, preliminarily approved by the court, and notice has gone out, making the blow provision a kind of insurance policy for defendants.  

While the blow provision-related side deal in RH was referred to in the parties’ settlement agreement, it went unmentioned in the motion for preliminary approval. In response to the omission, the judge ordered the parties to file the confidential agreement with the court under seal and advised both firms that she had informed the entire Northern District bench of the incident and of the firms’ respective identities.  

Given that the RH court characterized the settlement as a good deal for the class, counsels’ decision to bury the confidential agreement, and thereby incur the court’s ire, seems like a major unforced error. Certainly, failing to acknowledge the existence of a blow provision in prelim­inary approval motion is indefensible; indeed, plaintiffs’ counsel in RH acknowledged their “poor job” of disclosing the agreement at the June 18 hearing. Courts have a duty to assess the fairness, reasonableness, and adequacy of proposed class action settlements, an objective that is thwarted where the settlement is presented in an incomplete or misleading manner. On the other hand, plaintiff’s counsel was correct in noting that such agree­ments are “standard” in securities cases. Moreover, it is also quite common for the settling parties to request that blow provisions, which are typically memorialized in separate agreements like the one in RH, be subject to confidential treatment, i.e., that they not be publicly disclosed, even to class members. However, the court itself needs to be informed of the provision.  

On the surface, this type of secrecy seems antithetical to the informative aims of class action settlements: settle­ment proponents (plaintiffs and their counsel) are required to provide adequate notice of the settlement’s material terms to the class; in turn, class members are able to make an informed decision on whether to remain part of, opt out of, or object to, the settlement. More generally, absent class members who are not class representatives, and are therefore not directly involved with the litigation, should be kept abreast of critical developments by the plaintiffs and counsel who seek to represent their interests. This is especially true in cases such as RH, where a class had already been certified prior to the parties’ negotiating a settlement, thus creating, arguably, an even stronger presumption in favor of notice than in instances where a class is certified for the settlement purposes only. A previously-certified class has achieved a continuing and ongoing right to all material information about the case, making it difficult to advance the view that the blow provision’s terms have no bearing on individual class members’ decisions on how to proceed with respect to their claims, as has been argued in the settlement-only class certification context.  

Still, there are good reasons for both plaintiffs and defendants to resist public dissemination of the details of the blow provisions. Most prominently, publishing the number or percentage of opt-outs necessary to “blow up” a settlement may give excessive leverage to opt-out activists and threaten the stability of the settlement. Specifically, a group of class members with knowledge of the terms of the blow provision (and holding the requisite number of shares to trigger it) could band together for the purpose of preventing the settlement, or simply extracting special concessions from the settlement proponents. Even if the group did not initially have enough shares to trigger the termination provision, it could seek to recruit enough additional class members to do so. In cases where the claimed damages per share differ significantly among class members, tying the opt-out threshold to a specified dollar value could serve to impede this type of opt-out activism by making it more difficult to assemble the right mix of class members to trigger the blow provision.

Some courts have found these concerns sufficiently persuasive to warrant non-disclo­sure of supplemental agreements containing the opt-out threshold. Such courts will typically permit counsel to submit the supplemental agreement to the court through confidential means, so that the court’s mandate to review the settlement’s fairness is not impeded. Other courts have required that the supplemental agreement be publicly filed, reasoning that class members are entitled to review all aspects of the deal, even where that entails the possibility of a concerted effort to upend the settlement. Regardless, it does not appear that counsel risk any prejudice by not filing supplemental agreements memorializing blow provisions so long as they (a) refer to the existence of any such agreement in their motion papers and (b) file a timely request for confidential review of the agreement, e.g., a motion to file under seal. Alternately, the settling parties might elect simply to inform the court about the existence of the agreement and their non-intention to submit it in any form, confidential or otherwise, absent a specific order to do so. This course of action is not recommended, not only because it is likely to raise the court’s suspicions about the content of the agreement, but also because the court is then forced to issue a request for information in order to carry out its duty to evaluate the settlement’s fairness.

Plaintiffs and their counsel have no real interest in ensuring that a blow provision or appurtenant side agreement be included as part of a settlement – it is inevitably a condition imposed by defendants for purposes of limiting their own exposure to future cases brought by opt-out class members. Nevertheless, these agreements have become standard practice. This is unsurprising in light of research demonstrating that the number of opt-outs – and the potential for separate opt-out litigation – has increased in recent years. Large class action settlements represent a disproportionate percentage of cases that ultimately face an opt-out: between 2012 and 2014, three of four settlements of $500 million or greater involved opt-outs. Consequently, members of the securities plaintiffs’ bar must learn to effectively balance the informational risk posed by opt-out thresholds with both the notice due to class members and the court’s independent obligation to fully review the terms of class-wide settlements.

Statements About [The Absence of] Gender Discrimination Can Constitute Securities Fraud



With the emergence of the #MeToo movement, courts have seen an increasing number of securities fraud class actions based on allegations involving sexual discrimina­tion, harassment and other types of sexual misconduct. Such misconduct by itself does not constitute securities fraud. The added element that makes it a fraud is some public statement by the company to the effect that it does not engage in such conduct.  

When securities fraud actions involve allegations of sexual misconduct, the claims asserted typically involve public statements issued by a company about corporate values, integrity, and adherence to ethical standards, which are alleged to be false and misleading in light of actual misconduct known inside the company. That is exactly what happened at Signet Corporation.  

The company had gone out of its way to portray itself as harassment-free in its securities filings and other public statements. It highlighted its Code of Conduct, which said that Signet “made employment decisions ‘solely’ on the basis of merit”; that it was “committed to a workplace that is free from sexual, racial, or other unlawful harassment” and does not tolerate “[a]busive, harassing, or other offensive conduct ... whether verbal, physical, or visual”; that it has “[c]onfidential and anonymous mechanisms for reporting concerns”; that it disciplines “[t]hose who violate the standards in this Code”; and that it requires its senior officials to“[e]ngage in and promote honest and ethical conduct.” In its Form 20-F, filed with the SEC, Signet represented that adherence to the Codes, including by senior executives, was of “vital importance.” It represented that, in adopting both the Code of Ethics and the Code of Conduct, the company has “recognized the vital im­portance to the Company of conducting its business sub­ject to high ethical standards and in full compliance with all applicable laws and, even where not required by law, with integrity and honesty.” It said that it was committed to disciplining misconduct in its ranks and providing employees with a means to report sexual harassment with­out fear of reprisal.  

According to the securities class action complaint, reality was far different. The alleged sexual misconduct at Signet was at the heart of an arbitration proceeding (the “Jock” action) brought by approximately 200 allegedly victimized employees. Although the Jock proceeding was supposed to be confidential, some details about the experiences of these employees became public in February 2017 and were published in the Washington Post. Many female em­ployees had accused the company of discriminatory pay and promotion practices based on their gender. There were also credible accusations in the Jock proceeding that Signet had a culture of rampant sexual harassment – including, but not limited to, conditioning subordinate female employees’ promotions to their acceding to the sexual demands of their male supervisors (even those who held the highest positions in the company), and retaliating against those who reported this misconduct. Women alleged that sexual harassment routinely occurred at the company’s “Managers’ Meetings,” where male executives “sexually prey[ed]” on female subordinates.  

As discussed in the previous article in this issue, the recent decision in the Signet securities litigation forcefully rejected defendants’ argument, based on the Second Circuit’s decision in Singh v. Cigna Corp., that descriptions of codes of conduct are always inherently puffery that investors cannot take seriously. Archetypal examples of puffery include “statements [that] are explicitly aspirational,” “general statements about reputation, integrity, and compliance with ethical norms,” “mere[] generalizations regarding [a company’s] business practices,” and generalized expressions of “optimis[m].” As with the gen­eral standard governing materiality, determining whether certain statements constitute puffery entails looking at “context,” including the “specific[ity]” of the statements and whether the statements are “clearly designed to distinguish the company” to the investing public in some meaningful way. Finding that Signet’s statements about its code of conduct were very specific and went well beyond vague generalizations, the court in Signet refused to dismiss the action.  

Because gender issues involving corporate management have moved center stage, in recent years many companies have adopted codes of conduct prohibiting this kind of misconduct, and have discussed those codes in their securities filings and elsewhere. While that is certainly a step in the right direction, it is now clear that systematic violations of those codes can lead to securities claims.  

It is concerning to note that Signet’s egregious misconduct might never have become public, because the employees’ complaints were forced into secret arbitration proceed­ings. It was only by chance that the claims came to light and were picked up by the Washington Post. Mandatory arbitration clauses, a common business practice requiring workers and customers to waive their right to sue the com­pany in court, have kept sexual harassment complaints (such as those in the Jock action) hidden from the public.  

For some time, Democrats have introduced bills to ban or limit arbitration clauses. There now appears to be some bipartisan agreement that such practice raises concerns. Republican Senator Lindsey Graham, the chair of the House Judiciary Committee, recently scheduled a hearing on the topic, saying “in 2019, I want to look long and hard on how the system works; are there any changes we can make?” 

Statements About Corporate Legal and Regulatory Compliance Can Constitute Securities Fraud


In the wake of the financial crisis of 2008, investors have become more attuned to and concerned about the risks companies face, yet may fail to disclose to the market. Consequently, when previously undisclosed news of, for example, a company’s legal liability is revealed to the market or actually materializes, the company’s stock price may well drop sharply, damaging investors. Over the last few years, investors have increasingly brought securities claims over such conduct, sometimes referred to as “event-driven” litigation.  

In March of this year, the Second Circuit issued a decision in Singh v. Cigna Corp., which had one such event-driven claim which turned on whether the company’s public statements concerning its legal compliance were “material” to investors.  

Singh arose from Cigna Corp.’s acquisition of HealthSpring, Inc. for $3.8 billion in early 2012. Cigna, a health insurance and services company, acquired HealthSpring in order to grow its Seniors and Medicare business segment. At the time of the acquisition, HealthSpring was one of the largest private Medicare insurers in the United States. Accordingly, HealthSpring was heavily regulated by the Center for Medicare and Medicaid Services (“CMS”).  

Prior to the acquisition, HealthSpring had a spotless compliance track record—having never been cited for non-compliance by the CMS. That changed following the acquisition. Although Cigna’s acquisition first appeared to be successful, with HealthSpring becoming Cigna’s largest source of revenue within one year, shortly after the acqui­sition was completed Cigna began to receive CMS notices for non-compliance in its HealthSpring operations.  

Between October 2013 and January 2016, Cigna received a total of 75 Notices of Non-Compliance from CMS, culmi­nating in January 2016, when the regulator imposed severe sanctions on the company. On January 21, 2016, CMS notified Cigna that it would be imposing immediate sanctions which would prohibit it from writing any new Medicare policies, a significant blow to its most profitable business segment. Notably, CMS specifically concluded that “Cigna substantially failed to comply with CMS requirements” and that it “had a longstanding history of non-compliance with CMS requirements” as demonstrated by the receipt of numerous prior notices.  

By November 2016, Cigna had spent $100 million to remedy the problems identified by CMS, and was not yet finished. The sanctions were finally lifted on June 16, 2017.  

Plaintiff, representing a class of investors who purchased Cigna stock after the acquisition, alleged four sets of mis­representations concerning Cigna’s track record of legal compliance. First, Cigna stated in an annual report on Form 10-K filed with the SEC that it had “established policies and procedures to comply with applicable requirements.” Second, the Company repeatedly stated in its annual reports that it “allocate[s] significant resources to [its] compliance, ethics and fraud, waste and abuse programs to comply with the laws and regulations[.]” Third, Cigna acknowledged in its annual reports that failure to comply with state and federal health care laws and regulations can result in “fines, limits on expansion, restrictions or exclusions from programs or other agreements with fed­eral or state governmental agencies that could adversely impact [Cigna’s] business, cash flows, financial condition and results of operation.” Finally, the Plaintiff alleged that Cigna’s Code of Ethics and Principles of Conduct included a quote by one of the officer defendants which stated that it is important for Cigna to do things “the right way,” which includes reporting financial results fairly and accurately. Moreover, the quote continued that “it’s so important for every employee on the global Cigna team to handle[,] maintain, and report on this information in compliance with all laws and regulations.”  

The district court dismissed the action, holding that Cigna’s statements about compliance were so vague and conclusory that they amounted to mere “puffery,” and were so immaterial that investors could not reasonably rely on them. After plaintiff appealed the district court’s decision to dismiss his claims, the Second Circuit reviewed the materiality of the alleged misstatements. A misrepresen­tation is material if “there is a substantial likelihood that a reasonable person would consider it important in deciding whether to buy or sell shares of stock.” The statement must also be “mislead[ing],” which is evaluated not only by “literal truth,” but by “context and manner of presentation.” 

The plaintiff in Singh argued that the each of the three sets of alleged misrepresentations were material and misleading because “a reasonable stockholder would rely on these statements as representations of satisfactory legal compliance by Cigna.” The Second Circuit disagreed, affirming the dismissal.  

First, the Second Circuit characterized the Code of Ethics statement as “a textbook example of puffery,” as it ex­pressed “general declarations about the importance of acting lawfully and with integrity.” Accordingly, the Court found that no investor would rely on such statements.  

Similarly, the Court categorized Cigna’s statements in its annual reports concerning its “established policies” and its “significant”’ allocation of resources to compliance programs as mere “representations of satisfactory compli­ance,” which again, the Court found that no investor would reply upon. In making this determination, the Court dis­tinguished Cigna’s statements in its annual reports from the “descriptions of compliance efforts [which] amounted to actionable assurances of actual compliance” made by defendants in Meyer v. JinkoSolar Holding Co., which were found to be actionable.  

Finally, the Second Circuit found that each of Cigna’s statements in its annual reports were “framed” by acknowledgements of the complexity of applicable regulations. As a result, the Court found that Cigna sufficiently “caution[ed] (rather than [instill] confidence) regarding the extent of Cigna’s compliance,” and therefore, “these statements seem to reflect Cigna’s uncertainty as to the very possibility of maintaining adequate compliance mechanism in light of complex and shifting government regulations.”  

The defense bar has already hailed this decision as a lethal arrow in their quiver, claiming that it “will likely in­crease the dismissal rate of [event-driven securities] claims” and instructing defendants to “rely aggressively on Singh in seeking to have such suits dismissed.” Adam Hakki and Agnès Dunogué, “2nd Circ.’s Logical Take On ‘Event-Driven’ Securities Claims,” LAW360, May 13, 2019.  

Singh, however, is far from the decisive victory the defense bar promotes it to be. In the short time since it was handed down, district courts have continued to uphold securities claims concerning statements of legal compliance. In a recent decision following Singh, Signet Jewelers Limited argued that the Second Circuit’s opinion demanded that the plaintiff’s pleadings concerning Signet’s harassment protections in its Code of Conduct and Code of Ethics did not amount to material misrepresentations, and must be dismissed. Judge Colleen McMahon of the Southern District of New York found otherwise. Judge McMahon explicitly held that “Cigna did not purport to change the well-established law regarding materiality. It did not an­nounce a new legal rule, let alone one deeming an entire category of statements — those contained in a company’s code of conduct — per se inactionable.”  

Signet is not an outlier. In March of 2019, two months after Singh was decided, Judge Louis L. Stanton was presented with alleged misrepresentations in the Code of Ethics of Grupo Televisa, S.A.B., a multinational media conglomer­ate, following criminal charges that the company illegally paid bribes to obtain television rights to the FIFA world cup. Just as in Signet, defendants argued that the statements contained in the company’s code of ethics were mere puffery. Judge Stanton disagreed and found that the broad statements in the code of ethics (affirming the company’s commitment to legal compliance and prohibition of bribery) were actionable because they “were made repeatedly in an effort to reassure the investing [public] about the Company’s integrity, a reasonable investor could rely on them as reflective of the true state of affairs at the Company.”  

The Second Circuit’s decision in Singh demon­strates the importance and challenges of bringing securities claims over legal and regulatory failures by public corporations. The take-away of Singh for securities plaintiffs is that they must be evermore diligent in their pleadings, ensuring that judges are presented with specific and detailed representations concerning a company’s compliance such that in­vestors would be justified in taking them seriously.  Signet and Grupo Telavisia demonstrate that Singh certainly does not ring the death knell for similar types of event-driven litigation. Nevertheless, as the defense bar continues to rely upon this decision, it is critical for securities plaintiffs to monitor the decision’s precedential value. 

The Supreme Court Closes Another Door to Class Arbitration



In Lamps Plus, Inc. v. Varela, the Supreme Court issued the latest in a series of recent 5-4 decisions that have transformed arbitration law so as to make it much more difficult for plaintiffs to pursue claims as a class, whether in court or before an arbitrator. Following this decision, if an arbitration agreement is ambiguous about class arbi­tration, courts cannot rely on state contract law to interpret it in a way that best effectuates the contracting parties’ bargain. Instead, courts are now required to adopt a heavy presumption that arbitration agreements always prohibit class actions unless they include explicit authorization for class arbitration.   

These cases involved the Federal Arbitration Act (the “FAA”), a 1925 law intended “to enable merchants of roughly equal bargaining power to enter into binding agreements to arbitrate commercial disputes.” Arbitration offers contracting parties procedural flexibility to tailor a dispute resolution process to their specific commer­cial needs, which may include the efficient resolution of simpler disputes as well as expert resolution of technical disputes using procedural and evidentiary rules tailored to the industry. The FAA sought to overcome judicial hostility to arbitration by requiring courts to interpret and enforce arbitration agreements the same as any oth­er contract—i.e., to apply the same state law governing all other contracts and to effectuate the bargain of the parties instead of imposing courts’ own views of pro-cedural fairness and efficiency.  

However, commercial contracts are very different from most consumer and employment contracts. Procedural flexibility is less likely to be abused in commercial contracts because both parties have a shared incentive to structure a neutral process that can efficiently provide real relief. But in consumer and employment contexts, com­panies know they will be defendants and so have strong incentives to design and impose arbitral procedures that are one-sided at best and sometimes even deliberately inefficient in order to deter plaintiffs from bringing claims. (For example, prohibiting class actions essentially mandates individualized proceedings, which can be pro­hibitively costly and inefficient for many employee and consumer claims.) And in the past decade, the Supreme Court’s conservative wing—driven by its own hostility towards class actions—has not only approved of this prac­tice but has increasingly used the FAA to create its own special rules for arbitration agreements, overriding state laws governing every other type of contract.   

Lamps Plus, Inc. v. Varela illustrates this perfectly. The arbitration agreement in that case was part of an employ­ment contract. Unlike commercial contracts, employment and consumer contracts are usually written entirely by the company and then offered on a take-it-or-leave-it basis. Ordinarily, under the law of all 50 states, any ambiguities in a contract written entirely by a company are interpret­ed against the company and in favor of the employee or consumer. The rationale is that the company had every opportunity to protect its interests by writing clearer contractual language and so should not be able to benefit from any ambi­guities it created.   

But the Supreme Court did not apply this rule. The arbitration agreement did not explicitly authorize or waive class arbitration, but it did suggest in several places that class arbitration was available. First, it stated that “arbitration shall be in lieu of any and all lawsuits or other civil legal proceedings”—and “any and all law­suits” plainly includes class actions. Second, it allowed the arbitrator to “award any remedy allowed by applicable law”—which plainly includes a judgment on behalf of a class. Third and most importantly, the agreement provided for arbitration “‘in accordance with’” the rules of a specific arbitral forum whose rules allowed for class arbitration. As Justices Kagan and Sotomayor pointed out in their dissents, an employee reading the con­tract would have little reason to think they were waiving the right to proceed as a class. Thus, under ordinary contract law, an ambiguous contract like this should be interpreted in favor of the employee. If the employer cared about avoiding class arbitration, it had every opportunity to be clearer.  


Nevertheless, the Supreme Court held that arbitration agreements did not have to be clear in order to prohibit class arbitration. The majority’s stated rationale was that “shifting from individual to class arbitration is a ‘fundamental’ change … that ‘sacrifices the principal advantage of ar­bitration’ and ‘greatly increases risks to defendants” and therefore was so “markedly different from the traditional individualized arbitration contemplated by the FAA” that ambiguity was not enough. However, this rationale had no basis in the FAA, which never specifies any primary “advantage” of arbitration nor favors any particular kind of arbitral proceeding. (If anything, the whole point of the FAA was that contracting parties get to decide what they consider the “principal advantage” of arbitration for them­selves, and courts can’t use their own procedural views as excuses to treat arbitration agreements differently from other contracts.) Rather, as Justice Kagan pointed out in dissent, the Court simply used its “policy view … about class litigation” to “justify displacing generally applicable state law about how to interpret ambiguous contracts.” Moreover, while the conservative majority took great pains to protect corporate defendants from “increased risk,” it ignored the risks that its ruling will create for the other contracting parties, i.e., consumers and employees, who will have no practical remedy to vindicate their contractual rights.  

Notably, class-action waivers outside arbitration agree­ments rarely receive such special treatment, and their enforceability is much less clear. So after Lamps Plus, an arbitration agreement that is silent or deliberately vague about class arbitration is more reliable at blocking class claims than an explicit class-action waiver in a normal non-arbitration contract. This creates some strange incen­tives for companies that might otherwise have no interest at all in arbitration.

SEC Trims Public Company Disclosure Rules


After the stock market crash in October 1929 that led to the Great Depression, public confidence in the markets was at an all-time low. The Securities Act of 1933 and the Securities Exchange Act of 1934 were designed to restore confidence in public markets by providing investors with more reliable information.

On March 20, 2019, without an open meeting, the Securities Exchange Commission (“SEC”) voted to trim certain disclosure requirements for public companies. The only dissenting Commissioner was Robert Jackson. According to the SEC’s March 20, 2019 press release, “[t]he amendments are intended to improve the readability and navigability of company disclosures, and to discourage repetition and disclosure of immaterial information.”

The final amendments are consistent with the SEC’s mandate under the Fixing America’s Surface Transportation (“FAST”) Act. In 2015, Congress mandated the SEC to review Regulation S-K, the rules that describe what public companies must report in public disclosures, and to streamline where possible. The amendments are also based on recommendations in the SEC staff’s FAST Act Report as well as an overall review of the SEC’s disclosure rules. The amendments span a number of topics; the more significant amendments are discussed below.

Elimination of Confidential Treatment Request Process

Specifically, the amendments provide that in regulatory filings, public companies can redact confidential information in material contracts and certain other exhibits without submitting a confidential treatment request. Regulation S-K has been amended to provide that a public company can make this decision on its own, as long as the information is not material and would likely cause competitive harm to the company if publicly disclosed. While issuers will surely find this amendment to be one of the most welcome changes in the new rules, investors will clearly be left with less information, which is troubling.

Commissioner Jackson is also troubled by the new rule. In a March 26, 2019 public statement on the final rules, Commissioner Jackson stated:

The rule . . . removes our Staff’s role as gatekeepers when companies redact information from disclosures – despite evidence that redactions already deprive investors of important information.


Historically, we’ve required firms to work with our Staff when sensitive information is redacted from exhibits to registration statements. There are often good reasons for our Staff to permit redactions. But recent research shows that redactions already include information that insiders or the market deem material – showing how important careful review of these requests can be for investors.

Today’s rule removes both the requirement that firms seek Staff review before redacting their filings and the requirement that companies give our Staff the materials they intend to redact. The release doesn’t grapple with the effects of that decision for the marketplace. But one thing is clear: in a world where redactions already rob the market of information investors need, firms will now feel more free to redact as they wish. And investors, without the assurance that redactions have been reviewed by our Staff, will face more uncertainty.

Only Two-Year Discussion Needed in Management’s Discussion and Analysis

The SEC also amended the rules to provide that public companies may disclose less information in the Management Discussion and Analysis (“MD&A”) section of their filings. MD&As, which are the opinions of management, provide an overview of how the company performed in prior periods, its current financial condition, and projected results. This is one of the most closely reviewed parts of a company’s financial statements. Historically, in an annual report on Form 10-K or Form 20-F, a public company was required to address the three-year period covered by the financial statements included in the filing. In the final amendments as adopted, where companies provide financial statements covering three years in the filing, companies will generally be able to exclude discussion of the earliest of three years in the MD&A if they have already included the discussion in a prior filing.

Description of Property Holdings

Prior to amendment, the rules provided that public companies must disclose the location and general character of the principal plants, mines and other materially important physical properties of the registrant and its subsidiaries. Because the rule created ambiguity and elicited information that may not have been consistently material, the rules were amended to provide that public companies are required to disclose information about their physical properties only to the extent that it is material to the companies.

Two-Year Look-Back for Material Contracts

Prior to amendment, the rules required companies to file every contract not made in the ordinary course of business if the contract is material and (i) to be performed after the filing of the registration statement or report, or (ii) was entered into not more than two years before the filing. The amended rules limit the application of the two-year look-back requirement for material contracts only to newly reporting registrants.

The SEC Abandons a Proposed Amendment Regarding Legal Entity Identifiers

The SEC also decided not to adopt a proposed amendment that would have required companies to include legal entity identifiers (“LEIs”) of the registrant and each subsidiary listed in financial transactions. The LEI is a 20-digit, alphanumeric code that identifies legal entities participating in financial transactions. Given the increasingly complex organizational structures of companies, LEIs provide a precise standard for identifying legal entities responsible for risk-taking. Commissioner Jackson was troubled that this proposed amendment was abandoned. He was particularly concerned that “the financial crisis taught regulators that firms’ complex structures made it impossible to identify the corporate entities responsible for risk taking,” and that the Commission majority had provided “little evidence or reasoning” for eliminating that requirement. He concluded that, overall, the proposed new rules would “rob the market of information investors need to price decisions.”

The Take-Away

Pomerantz echoes Commissioner Jackson’s concerns that abandoning a proposed amendment regarding LEIs and trimming certain disclosure rules for public companies rob the market of information investors need to price decisions.

SEC Issues Expanded "Test-the-Waters" Communication Rules


On February 19, 2019, the U.S. Securities and Exchange Commission (the “SEC”) proposed a rule under the Securities Act of 1933, Rule 163B, that would relax regulatory burdens for all issuers, including investment company issuers. Specifically, the new rule would permit all issuers to solicit investor views about potential offerings and to consider these views at an earlier stage than currently is permissible. Such a rule would expand the “test-thewaters” accommodation that is currently available to emerging growth companies (“ECGs”). If adopted, this rule would result in earlier communications with potential investors to assist in evaluating the market and developing relationships with them.

The notion of test-the-waters was originally introduced when Congress passed the Jumpstart Our Business Startups Act (the “JOBS Act”) in 2012. Under the JOBS Act, ECGs are allowed to assess the interest of qualified institutional buyers and institutional accredited investors in connection with proposed securities offerings.

The proposed Rule 163B would allow issuers to engage in oral or written communications with potential investors that are, or that the issuer reasonably believes to be, qualified institutional buyers or institutional accredited investors. A qualified institutional buyer is a specified institution that owns and invests on a discretionary basis at least $100 million in securities of unaffiliated issuers. Institutional investors, including organizations not formed for the purpose of acquiring the securities offered and with assets in excess of $5 million, are considered accredited investors and must meet the criteria of SEC Rule 501(a)(1), (a)(2), (a)(3), (a)(7), or (a)(8), The SEC thus believes that these types of entities do not need the protection of the Securities Act’s registration process as they are more financially sophisticated than an average investor.

An issuer or person authorized to act on the issuer’s behalf would be required only to reasonably believe that a potential investor is a qualified institutional buyer or institutional accredited investor. The SEC failed to provide specific steps that an issuer could or must take to establish a reasonable belief that the intended recipient of the communications is qualified. Instead, the SEC is apparently assuming that issuers can and should continue to rely on current and previous methods used to assess an investor’s status.

SEC chairman Jay Clayton issued a press release announcing the proposed rule with the goal that “[e]xtending the test-the-waters reform to a broader range of issuers is designed to enhance [the issuer’s] ability to conduct successful public securities offerings and lower their cost of capital, and ultimately to provide investors with more opportunities to invest in public companies.”

Proponents of this new rule argue that in allowing more issuers to engage with a set of financially sophisticated institutional investors while the company is in the process of preparing for a securities offering could help issuers assess the demand for and value of their securities. Further, issuers would be able to discern which terms and structural components of the offering would be important to investors before the company incurs costs associated with the launch of an offering.

Ultimately, it appears that the SEC’s goal is to increase registered offerings in the United States. In doing so, the SEC believes that it can “have long-term benefits for investors and [the U.S.] markets, including issuer disclosures, increased transparency in the marketplace, better informed investors, and a broader pool of issuers in which any investor may invest.” According to the Wall Street Journal, the number of public companies has declined by about 50% since the mid-1990s. The JOBS Act failed to substantially increase the number of initial public offerings (“IPOs”) that occurred in the past few years. Close to 40% of eligible ECGs that conducted IPOs took advantage of the JOBS Act test-the-waters provision in 2015, but that percentage fell to less than 25% in 2016. It is difficult to ascertain at this time whether Rule 163B will increase IPOs. If that is the case, one can only hope that the SEC’s goal of providing issuers and investors flexibility and transparency alike does not lead to increased litigation regarding fraudulent claims as we have previously seen in IPOs filed and a company’s related subsequent stock drop.

Taking the potential benefits of Rule 163B into consideration, the next logical question that follows would be how these expanded rules play into the protection that investors would be afforded. Although the new rule would exempt test-the-waters communications and would need not be filed with the SEC, that is not to say that investors are left without any type of protection. The proposed rule provides that such communications would still be considered “offers” as defined under the Securities Act, thereby allowing liability and anti-fraud provisions to continue to be applicable. Further, the information disclosed during communications must not conflict with material information in the related registration statement and, as is the practice of the SEC when reviewing offerings conducted by EGCs, the SEC or its staff can “request that an issuer furnish the staff any test-the-waters communication used in connection with an offering.” Lastly, the SEC cautioned public companies that certain test-the-water communications could trigger disclosure under Regulation FD, which requires public companies to make public disclosure of any material non-public information that has been selectively disclosed to certain securities market professionals or shareholders. To avoid the application of Regulation FD, the SEC recommended having the recipient of the communication enter into a non-disclosure agreement to mitigate the need for public disclosure.

Flexibility and efficiency continue to be touted as reasons why this proposed rule is beneficial. The SEC argues that it will increase access to public capital markets by providing flexibility to issuers regarding their communications and determining which investors qualify under Rule 163B as intended recipients of such communications. As such, companies are in a better position to evaluate market interest and have discussions regarding the transaction terms required to address the most important concerns institutional investors may have, thereby providing a more efficient and effective capital-raising process. By the same token, the goal for investors will be transparency and obtaining information that may allow for more sound, confident financial decisions. Ultimately, investor protection must be at the forefront of any regulation created or amended by the SEC, without which interest in capital markets would greatly decrease.

Proposed Rule 163B was subject to a 60-day public comment period following its publication in the Federal Register. That period ended on April 29, 2019.

Can Shareholders Propose Bylaws Requiring Mandatory Arbitration of Securities Fraud Claims?


Last year it was revealed that Johnson & Johnson (“J&J”) had knowingly marketed talcum powder containing asbestos, which may have caused ovarian cancer in consumers. This revelation caused J&J’s stock price to plummet and triggered a securities fraud class action on behalf of investors. In an effort to thwart that class action and others, Professor Hal S. Scott, the Director of the Program on International Financial Systems at Harvard Law School, representing a small J&J shareholder, submitted a proxy proposal to the Company for a shareholder vote to approve a corporate bylaw that would require all securities fraud claims against the company be pursued through mandatory arbitration, and would waive class action rights.

Such a proposal, if adopted, would sound the death knell for all securities claims against the company. In particular, prohibiting class actions would make it economically unfeasible, in almost all cases, for anyone but the largest shareholders to bring such an action.

J&J decided to reject this proposal because it would violate state law, and obtained a No Action Letter from the SEC, indicating that the agency would not object to exclusion of the proposal. Undeterred, Professor Scott filed an action in Federal District Court in New Jersey contesting the rejection, in an action called The Doris Behr 2012 Irrevocable Trust v. Johnson & Johnson. The court denied Professor Scott’s motion for an order compelling J&J to include the Proxy Proposal for the shareholder meeting that recently took place, on grounds that the motion was too late for this year. Nonetheless, the case will continue on the merits and there is little doubt that Professor Scott will pursue the proposal next year. While to date J&J has excluded the proposal from its proxy materials, there is no certainty that it will do so in the future. Pomerantz has been retained by the Colorado Public Employees’ Retirement Association (“Colorado PERA”) to intervene in the Proxy Litigation to ensure that investors’ rights are protected. We believe that Colorado PERA, a large J&J investor that is also a putative class member in the pending class action arising from underlying securities fraud claims, is ideally suited to represent shareholders’ interests—including their appellate rights—in the Proxy Litigation.

Historically, the Securities and Exchange Commission (“SEC”) has opposed proposals to mandate arbitration of claims brought by IPO and open market purchasers. More recently, in response to questions posed at Congressional hearings in early 2018, SEC Chairman Jay Clayton committed to hold public hearings if the Commission rethought its position. Pomerantz and institutional investors such as Colorado PERA have been at the forefront of explaining to the SEC why such proposals are contrary to law and public policy supporting shareholder rights.

Our objection is based on the proposition that corporate bylaw provisions, such as the proposal here, violate the “internal affairs” doctrine that is a fundamental principle of state corporate law. As then-Chancellor Leo Strine (who is now Chief Justice of the Delaware Supreme Court) set out in Boilermakers Local 154 Ret. Fund v. Chevron Corp., under Delaware law, the “internal affairs” doctrine limits corporate bylaws to regulation of intra corporate disputes between management and shareholders, such as breaches of fiduciary duty and waste. Bylaws cannot govern “external relationships” between third-party contractors and investors whose claims arise from deception when they purchased their shares. Consistent with that rule, on December 11, 2018, in Sciabacucchi v. Salzberg, the Delaware Court of Chancery rejected Blue Apron’s adoption of a bylaw mandating that Securities Act claims be filed only in federal court. The court based this decision on the “internal affairs” doctrine, explaining that “there is no reason to believe that corporate governance documents, regulated by the law of the state of incorporation, can dictate mechanisms for bringing claims that do not concern corporate internal affairs, such as claims alleging fraud in connection with a securities sale.” For these reasons, the New Jersey Attorney General issued an opinion on January 29, 2019 stating unequivocally that “the Proposal, if adopted, would cause Johnson & Johnson to violate New Jersey state law [where Johnson & Johnson is incorporated], [and] in the opinion of my office, the Proposal should be excluded” from the Company’s proxy materials. The Attorney General based this determination on the text of the New Jersey Business Corporations Act (including recent amendments to the statute), New Jersey case law, and the Delaware cases described above.

While efforts to date have thwarted imposition of mandatory arbitration on federal securities law claims, continued vigilance is necessary. Professor Scott no doubt hopes to ultimately bring this matter to the U.S. Supreme Court for a ruling on whether the Federal Arbitration Act pre-empts state law restrictions on mandatory arbitration agreements. Starting with AT&T Mobility v. Concepcion, 563 U.S. 333 (2011), the Supreme Court has held that brokerage clients, consumers, employees and others can be compelled by “contract” to arbitrate any disputes. Investors will argue, though, that aside from the Supreme Court’s prior deference to state law for corporate governance matters, there is no “contract” between investors and companies when securities are purchased in the open market. The “contract” is only with the direct seller, and there is certainly no “consent” to the arbitration.

Pomerantz expects challenges will nonetheless arise in this area over the next few years and intends to continue its efforts to protect investor rights.

Supremes: Distributing False Statement Can Be Securities Fraud


In a case called Stoneridge brought by Pomerantz a decade ago, the Supreme Court approved the doctrine of “scheme liability,” holding that a defendant can be liable for securities fraud even if he never made a misleading statement to investors, so long as he participated in an “act, practice, or course of business which operates or would operate as a fraud or deceit.” Later, in Janus, the Court held that a defendant cannot be liable for a misleading statement made to investors unless he made the misstatement itself or had ultimate authority over the contents of that statement. Any lesser involvement, such as drafting the contents of the statement, could at most be considered “aiding and abetting,” which, under yet another Supreme Court decision, is not a violation.

These doctrines have now intersected in a recent Supreme Court decision in Lorenzo v. SEC. In this case, a false statement was made to investors, but the defendant was not the “maker” of the statement. The Supreme Court held that the defendant, who merely forwarded his boss’s false statement to his clients, was liable for securities fraud under the theory of scheme liability.

Scheme liability is based on the language of SEC Rule 10b-5, which makes it unlawful to (a) “employ any device, scheme, or artifice to defraud,” … or (c) “engage in any act, practice, or course of business which operates or would operate as a fraud or deceit … in connection with the purchase or sale of any security.” The question before the Court in Lorenzo was whether those who do not “make” the misleading statements, but who disseminate them to investors with the intent to defraud, can be found to have violated subsections (a) and (c) and other related provisions of the securities laws. Defendant Lorenzo argued that scheme liability applies only when there are no false statements; otherwise, someone could be held liable for a false statement even if he did not make the statement himself. The Supreme Court rejected that argument.

Lorenzo was a director of investment banking at Charles Vista, LLC (“Charles Vista”). Lorenzo’s client, Waste2Energy, publicly touted that its assets were worth about $14 million, but Lorenzo knew that this figure included intellectual property claimed to be valued at $10 million that, as he later testified, was a “dead asset” that “didn’t really work.” In 2009, Waste2Energy hired Charles Vista to sell debentures to investors. In the fall of 2009, Waste2Energy told Lorenzo that the company had written off all its intellectual property as “worthless,” which left the company with a net worth of $370,552. Still, Lorenzo sent two emails to potential investors that described the debentures as having “multiple layers of protection,” including “$10 million in confirmed assets.” Lorenzo testified that he had not composed the emails himself but had merely forwarded them to clients at the direction of his boss. But he did know they were false.

The Supreme Court held that Lorenzo’s dissemination of false or misleading statements fell within the scope of subsections (a) and (c) and subjected him to scheme liability. The Court held that because Lorenzo sent emails that he knew contained material untruths, he had “employed” a “device,” “scheme,” and “artifice” to “defraud” and had violated subsection (c) because he “engage[d] in a[n] act, practice, or course of business” that “operate[d] … as a fraud or deceit.” The Court, repeatedly noting that Lorenzo’s conduct easily fell within the ambit of both subsections (a) and (c), relied on dictionary definitions of the words contained in those subsections to emphasize that they apply to a wide range of misconduct.

The Court also repeatedly emphasized that its conclusion is consistent with the purpose of the securities laws. For example, the Court noted that the application of subsections (a) and (c) to a broad range of misconduct is consistent with the principle established in the Court’s decision in SEC v W.J. Howey & Company over seventy years ago: “to substitute a philosophy of full disclosure for the philosophy of caveat emptor in the securities industry.” Similarly, the Court noted that its broad interpretation of subsections (a) and (c) was consistent with the principle highlighted in an earlier decision in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A.: that even a “bit participant in the securities market … may be liable as a primary violator under Rule 10b-5,” so long as all of the other requirements are met.

It rejected Lorenzo’s argument that subsections (a) and (c) apply only to conduct that did not involve misstatements, and since he was not the “maker” of an untrue statement under subsection (b), none of the provisions of Rule 10(b)-5 applied to him. The Court held that this argument was irreconcilable with the plain and expansive language of subsections (a) and (c), and further held that sustaining Lorenzo’s argument would allow those who disseminate, but do not make, statements to escape liability altogether. The Court also rejected Lorenzo’s and the dissent’s claim that an application of subsections (a) and (c) to his conduct would render the Court’s decision in Janus a “dead letter.” It noted that Janus remains relevant where an individual neither makes nor disseminates false or misleading statements. Because Lorenzo clearly disseminated false statements and, in fact, did not contest that he did so intentionally, the Court held that he violated subsections (a) and (c) of Rule 10b-5 even if he was not the “maker” of the statements under subsection (b).

The distinction between aiding and abetting, which is not actionable, and engaging in a scheme to defraud, which is, will doubtless continue to pose perplexing issues for courts well into the future. It is hard to understand why drafting a misstatement is OK, while sending that misstatement to someone else is not.

Pomerantz Achieves $110 Million Class Action Settlement in Fiat Chrysler Litigation


In a significant victory for investors, Pomerantz, as lead counsel for the class, has achieved a $110 million settlement with Fiat Chrysler Automobiles N.V. as well as certain of Fiat Chrysler’s former executives. Judge Jesse Furman in the district court of the Southern District of New York granted preliminary approval of the settlement on April 10, 2019 and set the final approval hearing for September 5, 2019.

The litigation against one of the world’s largest car manufacturers involved accusations that the defendants misled investors when they asserted that the company was complying with its obligations to conduct safety recalls under regulations promulgated by the National Highway Traffic Safety Administration (“NHTSA”) as well as with emissions regulations, promulgated by the Environmental Protection Agency (“EPA”) and the European Union, designed to control emissions of Nitrogen Oxide (“NOx”). In truth, Fiat Chrysler had a widespread pattern of violations dating back to 2013, in which the company would purposefully delay notifying vehicle owners of defects and failing to repair the defects for months or years. The company also improperly outfitted its diesel vehicles in the U.S. and Europe (including Jeep Grand Cherokee and Ram 1500) with “defeat device” software designed to cheat NOx emissions regulations. The defeat device software, which was similar to that employed by Volkswagen in the highly publicized “Dieselgate” scandal, was able to detect when the vehicle was being tested by a regulator (such as the EPA). When testing conditions were detected, the vehicle would perform in a compliant manner, limiting emissions of NOx. When testing conditions were not detected, such as during real-world driving conditions, the emissions controls were disabled, and the vehicles would spew illegal and dangerous levels of NOx.

The truth concerning Fiat Chrysler’s violations was revealed in a series of disclosures that caused the company’s stock price to plummet. On July 26, 2015, NHTSA announced a Consent Order against Fiat Chrysler, fining the company a record-high $105 million and requiring a substantial number of recalls and repairs. On October 28, 2015, the company announced a $900 million charge to earnings for an increase in estimated future recalls. The company’s stock price also declined in 2016 and 2017, when the EPA and other US and European regulators publicly accused Fiat Chrysler of using defeat devices to cheat NOx emissions regulations.

The settlement was achieved after three and a half years of hard-fought litigation. Discovery was wide-ranging. It involved analyzing millions of pages of documents concerning highly complex issues of emissions software programming and resulted in the exchange of reports by eleven experts on issues implicating U.S. as well as European regulations. The claims ultimately survived multiple rounds of motions to dismiss. Initially the emissions allegations were dismissed because the court determined that the complaint did not plead facts sufficient to demonstrate that the defendants knew that their statements of compliance were misleading. We were given leave to replead, and Pomerantz then filed Freedom of Information Act requests with the EPA. Its response included emails from Fiat Chrysler executives showing that they knew that the EPA had discovered certain defeat devices on the company’s vehicles. The defendants nevertheless continued to falsely assure investors that the company’s vehicles were compliant and did not contain any such defeat devices. When we filed an amended complaint that included those facts, these additional allegations revived the emissions claims.

Ultimately Pomerantz secured class certification on behalf of investors, which was followed by summary judgment proceedings. As the prospect of trial loomed, defendants finally agreed to the settlement.

In addition to creating precedent-setting case law in successfully defending the various motions to dismiss, Pomerantz also significantly advanced investors’ ability to obtain critically important discovery from regulators that are often at the center of securities actions. During the course of the litigation, Pomerantz sought the deposition of a former employee of NHTSA. The United States Department of Transportation (“USDOT”), like most federal agencies, has enacted a set of regulations — known as “Touhy regulations” — governing when its employees may be called by private parties to testify in court. On their face, USDOT’s regulations apply to both current and former employees. In response to Pomerantz’s request to depose a former NHTSA employee that interacted with Fiat Chrysler, NHTSA denied the request, citing the Touhy regulation. Despite the widespread application, and assumed appropriateness, of applying these regulations to former employees throughout the case law, Pomerantz filed an action against USDOT and NHTSA, arguing that the statute pursuant to which the Touhy regulations were enacted speaks only of “employees,” which should be interpreted to apply only to current employees. The court granted summary judgment in favor of Pomerantz’s clients, holding that “USDOT’s Touhy regulations are unlawful to the extent that they apply to former employees.” This victory will greatly shift the discovery tools available, so that investor plaintiffs in securities class actions against highly-regulated entities (for example, companies subject to FDA regulations) will now be able to depose former employees of the regulators that interacted with the defendants during the class period to get critical testimony concerning the company’s violations and misdeeds.

The firm’s perseverance resulted in a recovery that provides the class of investors with as much as 20% of recoverable damages—an excellent result when compared to historical statistics in class action settlements, where typical recoveries for cases of this size are between 1.6% and 3.3%.

The Institute For Legal Reform's Latest Attack on Shareholders


Each year around this time, corporate-backed lobbyists issue reports in order to reinvigorate their endless crusade against investor protections. Most recently, the U.S. Chamber of Commerce’s Institute for Legal Reform published a paper urging Congress to consider further limits on securities litigation, including an unprecedented damages cap that would severely curtail the ability of institutional investors to recover losses. Titled “Containing the Contagion,” the paper places ideology above fact, ignoring the actual statistics regarding securities litigation and its beneficial impact on holding perpetrators of fraud responsible to their victims.

Even a cursory review of the Institute’s arguments shows their fallacy. First, the Institute claims securities fraud cases have “exploded.” The data cited tells a different story. Last year, 221 non-M&A securities fraud class actions were filed, only slightly more than 214 in the prior year, and somewhat above an average of 182 cases over the past 20 years. Higher, yes, but well below the prior high of 242.

More importantly, the Institute does not address the rise in corporate fraud driving the uptick in securities fraud litigation. Each month brings new revelations of corporate misconduct, suggesting that Congress needs to increase, not cut, investor remedies. From LIBOR-rigging to Petrobras to the Billion Dollar Whale to Theranos, fraud has become more frequent and brazen in recent years. Startups and life sciences companies have hit investors especially hard. Embracing Silicon Valley’s “fake it until you make it” culture, many of these companies show little hesitation to tell investors whatever is necessary to raise capital, whether truthful or not.

While the Institute would prefer to blame lawyers rather than fraud perpetrators for the uptick in filings, facts do not support that conclusion. Dismissal rates for securities fraud cases have dropped substantially since 2015, reflecting the strong factual underpinning for recent cases. Further, securities fraud cases are filed in only a tiny minority of statistically significant stock drops, not indiscriminately. Once filed, courts apply one of the highest pleading standards under federal law, ensuring that only meritorious cases proceed. Courts also assess whether each pleading is frivolous, and must impose sanctions for those that are. The fact that courts have assessed thousands of complaints but only imposed a handful of sanctions demonstrates that current standards are working.

The Institute’s conclusions about M&A filings also defy logic. The paper cites an increase in federal M&A filings, the result of an ongoing shift in M&A lawsuits from Delaware state court to federal court. But, as Cornerstone Research confirmed in its most recent tally, the overall rate of M&A lawsuits has declined in recent years, slipping 11% below the average annual rate.

The Institute next takes aim at what it calls “eventdriven” litigation—a securities fraud lawsuit brought after an issuer has misrepresented a risk that comes to fruition. For example, if a medical device company misrepresented known safety defects, and patients later died, triggering investor losses, the Institute would call ensuing shareholder litigation “event-driven.” Any concerns about such litigation are overblown. Shareholders will only be able to sustain securities cases, however labeled, if they have a factual basis to properly allege scienter, falsity and loss causation. As a result, courts will quickly weed out any lawsuits based only on an unforeseen triggering event.

None of the Institute’s arguments supports the most drastic remedy it urges Congress to consider: a damages cap that would deprive institutional investors of compensation for injuries suffered as a result of securities fraud. Specifically, the Institute proposes that the damages payable by securities fraudsters be capped at an arbitrary, unspecified amount for all cases other than those arising from initial public offerings, and that small investors be prioritized in the allocation of those damages. To justify this proposal, the paper repeats the discredited claim that securities fraud litigation is just “pocket shifting” for large, diversified investors, supposing that the investors gain on securities litigation settlements but also lose when other companies in which they invest have to pay out settlements. No academic research has shown this to be the case. In fact, a recent study found a statistically significant rise in share prices when a corporate securities fraud defendant announces a settlement. As a result, institutional investors benefit both from receiving settlement proceeds, and from the boost in valuation when portfolio companies come clean with investors.

While unpopular among some special interests, private securities litigation has returned tens of billions of dollars to defrauded investors. Even after fees and expenses, private securities fraud litigation remains the most important source of recovery for defrauded investors, far outpacing the SEC. The Institute’s latest anti-investor positions may satisfy its backers, but they do not justify any rollback of investor protections.  

The Supreme Court's Unanimous Decision in Tims V. Indiana Represents A Decisive Victory for Criminal Justice Reform


In an era where many states and localities are trying to plug their budget deficits by imposing draconian “civil forfeitures” on alleged criminals, the Supreme Court’s unanimous decision in February in Tims v. Indiana is a decisive victory against some of the most egregious abuses stemming from this practice. In this case, defendant Tims argued that the state of Indiana imposed an excessive fine on him when it seized his sports utility vehicle, valued at $42,000, after he was arrested for selling heroin. The value of this SUV was more than four times the maximum $10,000 monetary fine assessable against Tims for his drug conviction. The Supreme Court, in an opinion authored by Justice Ruth Bader Ginsburg, overturned the forfeiture and, in the process, held that the Eighth Amendment’s Excessive Fines Clause applies to the states under the Fourteenth Amendment’s due process clause, because it is a safeguard “fundamental to our scheme of ordered liberty” with “deep roots in our history and tradition.”

Tims pleaded guilty in Indiana Court to selling heroin to undercover officers. In addition to sentencing Tims to a year of house arrest, five years’ probation, and assessing reasonable fines and fees, Indiana sought civil forfeiture of a $42,000 SUV Tims had purchased with the proceeds of an insurance policy he received when his father died. The trial court denied Indiana’s request, noting that the vehicle had been recently purchased (and was therefore not likely part of the proceeds of his crime) and was valued at more than four times the maximum fine. Therefore, the trial court determined that the seizure of the SUV would be grossly disproportionate to Tims’ crime and unconstitutional under the Eighth Amendment’s Excessive Fines Clause. The Court of Appeals affirmed, but the Indiana Supreme Court reversed, holding that the Excessive Fines Clause did not apply to state action. Tims appealed.

As Justice Ginsburg remarked, the Supreme Court has held, with only a handful of exceptions, that the Fourteenth Amendment’s Due Process Clause “incorporates” many of the protections in the Bill of Rights, thus rendering them applicable to the states. A Bill of Rights protection is incorporated if it is “fundamental to our scheme of ordered liberty.” In holding that the Excessive Fines Clause is “fundamental to our scheme of ordered liberty,” Justice Ginsburg traced the adoption of the prohibition against excessive fines back to the Magna Carta, the Virginia Declaration of Rights, and similar colonial-era provisions. Justice Ginsburg also noted that by the time the Fourteenth Amendment was ratified, 35 of the 37 states expressly prohibited excessive fines in order to guard against such fines being used to subjugate the newly freed slaves “and maintain the prewar racial hierarchy.” Justice Ginsburg further noted that historically, excessive fines were used to undermine other constitutional liberties.

Indiana argued that the Clause, as applied to in rem forfeitures (i.e. seizure of specific property), is neither “fundamental” nor “deeply rooted.” In Austin v. United States, the Court held that civil in rem forfeitures fall within the Excessive Fines Clause protection when they are at least partially punitive. While Austin arose in the federal context, the Court noted that when a Bill of Rights protection is incorporated, the protection applies identically to the federal government and the states.

The Court held that the proper question in determining whether the Fourteenth Amendment incorporates a protection contained in the Bill of Rights is whether the right guaranteed – rather than each and every particular application of that right – is fundamental or deeply rooted. Thus, regardless of whether application of the Excessive Fines Clause to civil in rem forfeitures is itself fundamental or deeply rooted, the conclusion that the Clause is incorporated remains unchanged. The Court remanded the case to the Indiana Supreme Court for determination of whether the seizure of Tims’ SUV was excessive under this standard.

The Tims decision was cheered by advocates of criminal justice reform who have argued that civil asset forfeiture laws create an incentive for abuse. In many places, such laws facilitate the seizing of assets from individuals who have not been convicted of or even charged with a crime, and require only a tenuous connection between the crime and the seized asset. For example, in January 2019 an investigation conducted by The Greenville News and Anderson Independent Mail uncovered that the South Carolina police seized more than $17 million over a three year period through civil asset forfeiture. The investigation concluded that a review of the cases demonstrates that the “police are systematically seizing cash and property—many times from people who aren’t guilty of a crime— netting millions of dollars each year” and that “nearly a fifth of the 4,000 people who had their property seized by South Carolina police between 2014 and 2016 were never arrested nor even charged with a related crime.”

Additionally, critics of civil asset forfeiture laws contend that they are disproportionally harmful to lower-income communities and communities of color. For example, an investigation conducted by The Washington Post concluded that “of the 400 court cases examined where people challenged seizures and received money back, the majority were Black, Hispanic or another minority.” Another investigation found that Philadelphia cash forfeitures disproportionally target African-Americans who, while making up 44% of the population, are subject to an astounding 71% of forfeitures without conviction.

Critics of the Tims decision argue that the ruling will create financial challenges to police departments that have come to rely on civil forfeitures as a way to finance police operations. After Tims, they will have to look elsewhere for their funds.

Section 14(a) And Inadequate Risk Disclosures


In Jaroslawicz v. M&T Bank Corporation, the Third Circuit Court of Appeals recently held that allegations that defendants failed to disclose M&T Bank Corporation’s (“M&T”) compliance violations in a proxy statement issued in connection with M&T’s merger with Hudson City Bancorp (“Hudson”) could be a violation of Section 14(a) of the Exchange Act, which prohibits proxy fraud. The Court explained that the omission of information from a proxy statement violates Section 14(a) and the Securities and Exchange Commission (“SEC”) Rule 14a-9 if, among other reasons, “the SEC regulations specifically require disclosure of the omitted information.” The parties therefore agreed that Section 14(a) required the Joint Proxy to comply with Item 503(c) of SEC Regulation S-K. Item 503(c), in turn, requires issuers to “provide under the caption ‘Risk Factors’ a discussion of the most significant factors that make the offering speculative or risky.”

The parties disagreed, however, over whether M&T’s alleged past consumer violations posed a risk to regulatory approval of the merger and whether M&T had adequately disclosed the risk of M&T’s Bank Secrecy Act/Anti-Money Laundering (“BSA/AML”) deficiencies.  The Third Circuit concluded that the complaint plausibly alleged that M&T’s consumer violations “made the upcoming merger vulnerable to regulatory delay” and that the defendants did not adequately disclose the risk of M&T’s BSA/AML compliance violations. The Court’s decision thus emphasizes the breadth of factors that must be disclosed under Item 503(c) and the highly specific level at which defendants must disclose that information or be subject to liability under the federal securities laws.

According to the District Court, Item 503(c) did not require the defendants to disclose M&T’s consumer violations because the complaint did not adequately allege that those past violations posed a significant risk to the merger at the time the Joint Proxy was issued. In addition, the District Court held that M&T adequately disclosed the risk that its BSA/AML deficiencies posed to the merger by describing the general risk of regulatory oversight related to BSA/AML compliance issues. The Third Circuit disagreed with both of these conclusions.

First, the Third Circuit held that Item 503(c) required disclosure of M&T’s consumer rights violations because “[d]espite the fact that M&T had ceased [those violations], it is plausible that the allegedly high volume of past violations made the upcoming merger vulnerable to regulatory delay.” The Court then assessed whether the proxy materials adequately disclosed this risk factor as required by Item 503(c). As the Third Circuit explained, “generic disclosures which could apply across an industry are insufficient. Rather, adequate disclosures are companyspecific. They include facts particular to a company, such as its financial status, its products, any ongoing investigations, and its relationships with other entities.” The Court concluded that the plaintiffs plausibly alleged that the Joint Proxy’s disclosures concerning consumer violations, which “discussed the regulatory framework facing consumer banks” in general—but did not mention M&T’s fraudulent practices or the Consumer Financial Protection Bureau’s investigation into them—“were too generic to be adequate.”

As for M&T’s BSA/AML deficiencies, the Court held that “it is plausible that the[] boilerplate disclosures were too generic to communicate anything meaningful about this specific risk to the merger.” For example, although the Joint Proxy mentioned AML compliance requirements at a general level, it did not describe M&T’s “Know Your Customer” program, the bank’s alleged deficiencies, or the Federal Reserve Board’s investigation into them. Fur - thermore, because M&T’s supplemental disclosure of the Federal Reserve Board’s identification of these deficien - cies, which M&T noted would likely delay the merger, was made, at most, six days before the shareholder vote on the merger, the adequacy of these supplemental disclosures “raise[d] a fact issue, which preclude[d] dismissal of the BSA/AML allegations.”

The Court therefore concluded that the complaint ad - equately alleged a violation of Item 503(c)—and, by extension, Section 14(a)—and vacated the District Court’s dismissal of the mandatory-disclosure claims relating to M&T’s consumer rights violations and its BSA/AML deficiencies.

The Court, however, rejected claims that the defendants had failed to disclose information that might have contradicted their expressed opinions of confidence that the merger would be approved expeditiously. Plaintiffs alleged that defendants violated their duty to disclose facts that allegedly would have shown that they had little or no basis for these opinions. In its decision in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, the Supreme Court held that defendants have a duty to disclose information that forms the basis for their opinions when the omission of that information makes the opinion statements at issue misleading to a reasonable person. The Court here determined that the complaint did not allege specific undisclosed facts about the defendants’ knowledge of, or investigation into, M&T’s compliance violations that would have belied their stated opinion that the merger should obtain regulatory approvals in a timely manner.

Although this case dealt specifically with a claim brought under Section 14(a) of the Exchange Act, the Court applied the same standard that other circuits have applied to determine what disclosures Item 503(c) requires under the Securities Act. While these separate statutory provi - sions might cover different securities filings or participants, the Court explained that those distinctions are immaterial for purposes of determining the content of the disclosures required by Item 503(c). The Third Circuit’s decision in M&T helpfully sets out the standard for the duty to dis - close risk factors under Item 503(c), the violation of which gives rise to liability in connection with covered securities filings, including under Section 14(a) of the Exchange Act and Sections 11 and 12 of the Securities Act. In particular, the Court made clear the SEC’s concern that “inadequate disclosure—particularly in the form of disclosing only generic risk factors—presents a persistent problem.” Defen - dants must therefore disclose all of the most significant risk factors in a company-specific way, rather than relying on the common—but insufficient—practice of providing generic warnings that could apply to any company or an industry as a whole.

Courts Tackle Merger Proxy Rules Supremes To Determine Fate of Merger Litigation


Section 14(e) of the Exchange Act prohibits fraudulent, deceptive, and manipulative acts in connection with a tender offer. Mergers are often implemented through tender offers, which are accompanied by offering statements and recommendations from the target corporation.

On January 4, 2019, the Supreme Court granted certiorari in Varjabedian v. Emulex Corp., to review the Ninth Circuit’s holding that to state a claim under Section 14(e), shareholders need allege only that a misrepresentation or omission in connection with a tender offer was negligent. This case is of critical importance to the future of securities litigation relating to mergers. The Court could significantly expand Section 14(e) claims by siding with the Ninth Circuit (and against five other circuit courts) by holding that Section 14(e) requires only allegations of negligence, rather than proof of scienter (i.e., the intent to defraud). Alternatively, the Court might decide that no private right of action exists under Section 14(e) at all, and so significantly curtail merger-related securities litigation.

In Emulex, a shareholder of Emulex Corp. brought a Section 14(e) class action against the company following the merger of Emulex and Avago Technologies Wireless Manufacturing, Inc., two companies that sold storage adapters, network interface cards, and related products. Pursuant to the terms of a merger agreement, the Avago merger sub had initiated a tender offer for Emulex’s outstanding stock to obtain control of Emulex. In connection with this tender offer, Emulex issued a statement to shareholders recommending that they accept the offer. This statement included a summary of a non-public analysis Emulex had commissioned from Goldman Sachs of the fairness of the proposed merger. Goldman Sachs’s original fairness analysis included a comparison of the premium shareholders would receive in the tender offer and the premium of previous offers for similarly situated companies, and concluded that the premium, while below average, was within the normal range. Emulex omitted this analysis of premiums from its summary of Goldman Sachs’s fairness analysis. The complaint alleged that this omission rendered Emulex’s tender offer statement misleading, in violation of Section 14(e). The district court dismissed the complaint on the ground that it failed adequately to allege scienter.

The Ninth Circuit reversed the district court’s decision and held that only negligence, rather than scienter, need be pleaded to state a claim under Section 14(e). The Court noted that Section 14(e) contains two clauses, each prohibiting different conduct: the first clause prohibits “mak[ing] any untrue statement of material fact” and misleading omissions, while the second clause prohibits “engag[ing] in any fraudulent, deceptive, or manipulative acts or practices, in connection with any tender offer. ...” Each clause proscribes different conduct, as otherwise one clause would be superfluous. The Court then noted that the Supreme Court, in Aaron v. SEC, in interpreting the wording of Section 17(a)(2) of the Securities Act— which is nearly identical to the wording in the first clause of Section 14(e) —had held that that language did not require a showing of scienter.

The Ninth Circuit also addressed the Supreme Court’s holding, in Ernst & Ernst v. Hochfelder, that claims under Section 10(b) of the Exchange Act and Rule 10b-5 must allege scienter. The Court in Ernst expressly held that language nearly identical to that in the first clause of Section 14(e) could be read as proscribing negligent conduct, not merely intentional conduct. Nevertheless, the Ernst Court concluded that SEC Rule 10b-5 requires a showing of scienter because the enabling statute, Section 10(b) of the Exchange Act, permits the SEC to regulate only “manipulative or deceptive device[s],” and manipulation and deception are intentional acts. 15 U.S.C. § 78j(b). As the SEC cannot proscribe a broader range of conduct than permitted by the enabling statute, the Court interpreted Rule 10b-5 to prohibit only intentional conduct.

In concluding that Section 14(e) requires only negligent conduct, the Ninth Circuit broke with the Second, Third, Fifth, Sixth, and Eleventh Circuits, all of which previously had held that Section 14(e) required scienter. The Ninth Circuit disagreed with the analysis of those other circuits and held that they had failed to apply the holdings in Aaron and Ernst. The other circuits each had interpreted the language of Section 14(e) with reference to Rule 10b-5 and had concluded that because language in the latter had been found to require scienter, the former should as well. Yet these cases, the Ninth Circuit found, failed to recognize that the language in Rule 10b-5 required scienter only because the enabling statute limited scope of the Rule to intentional conduct. Circuit cases decided after Aaron and Ernst failed to recognize that the Supreme Court twice had interpreted language nearly identical to that in Section 14(e) to encompass negligent conduct.

Following the Delaware Court of Chancery’s 2016 ruling in Trulia that required greater scrutiny of cases alleging insufficient disclosures relating to a merger, shareholders increasingly have chosen to bring their merger-related claims in federal rather than state court. If the Supreme Court adopts the Ninth Circuit’s reasoning in Emulex and permits Section 14(e) cases to proceed based merely on allegations of negligence, federal merger-related securities litigation likely will increase even more significantly. However, the Court, with its additional conservative members, may be loath to endorse such a result and may simply adopt the holdings of the five circuits that have found that Section 14(e) requires scienter. However, the Court may take this case as an opportunity to address whether there is an implied private cause of action under Section 14(e) at all. If the Court finds that no implied private cause of action exists under Section 14(e), the holding may result in a significant curtailment of merger-related securities litigation. Moreover, this holding may encourage companies to use the tender offer more often for business combinations (in place of traditional mergers with board approval) so as to avoid private litigation, and so may curtail merger-related litigation even further.

Pomerantz Achieves Settlement with Barclays plc


As this issue of the Monitor was going to press, Pomerantz, as sole Lead Counsel, achieved a $27 million settlement on behalf of the Class in Strougo v. Barclays PLC, which is pending court approval. In this high-profile securities litigation, plaintiffs alleged that defendants Barclays PLC, Barclays Capital US, and former head of equities electron­ic trading William White, concealed information and misled investors regarding its management of its Liquidity Cross, or LX, dark pool -- a private off-exchange trading platform where the size and price of orders are not revealed to other participants.

Specifically, during the Class Period, Barclays touted its Liquidity Profiling tool, describing it as “a sophisticated surveillance framework that protects clients from predatory trading activity in LX,” while promoting LX as “built on transparency” and featuring “built-in safeguards to manage toxicity [of aggressive traders].” However, the suit alleges that rather than banning “predatory” traders, Barclays actively encouraged them to enter the pool, applied manual overrides to re-categorize “aggressive” clients as “passive” in the Liquidity Profiling system, failed to police LX to prevent and punish toxic trading, intentionally altered marketing materials to omit reference to the largest predatory high frequency trader in LX, and preferentially routed dark orders to LX where those orders rested for two seconds seeking a “fill” vulnerable to toxic traders. This preferential treatment to high-frequency traders allowed them to victimize other dark pool investors by trading ahead of anticipated purchase and sell orders, thereby rapidly capitalizing on proprietary information regarding trading patterns.

In certifying the Class in February 2016, Judge Shira S. Scheindlin of the federal district court in the Southern District of New York held that even though the dark pool was just a tiny part of Barclays’ overall operations, defendants’ fraud was qualitatively material to investors because it reflected directly on the integrity of management. Defendants appealed Judge Scheindlin’s ruling in the Second Circuit Court of Appeals.

Pomerantz, in successfully opposing the appeal, achieved a precedent-setting decision in November 2017, when the Second Circuit affirmed Judge Scheindlin’s class certifica­tion ruling. The Court held that direct evidence of market efficiency is not always necessary to invoke the Basic presumption of reliance, and was not required here. The Court further held that Defendants seeking to rebut the presumption must do so by a preponderance of the evidence. This ruling will form the bedrock of class action securities litigation for decades to come.

Pomerantz Managing Partner Jeremy Lieberman stated, “We are extremely pleased with this settlement, which represents more than 28 percent of plaintiffs’ alleged recoverable damages,” he said, “well above the norm in securities class actions.”

Pomerantz Partner Tamar A. Weinrib led the litigation with Managing Partner Jeremy Lieberman and Pomerantz Senior Partner Patrick V. Dahlstrom.

In The Beginning...


In its landmark 2014 decision, Kahn v. M&F Worldwide, known colloquially as MFW, the Delaware Supreme Court held that the deferential business judgment standard of re­view will apply to going private mergers with a controlling stockholder and its subsidiary if and only if the merger is conditioned “ab initio” —Latin for “from the beginning” — on two specific minority stockholder protective measures. Once a transaction has business judgment rule review, the Court will not inquire further as to sufficiency of price or terms absent egregious or reckless conduct by a Special Committee. Deals subject to the “entire fairness” standard of review have a significantly tougher time getting judicial approval than those subject to review under the business judgment rule.

These two conditions, which the controlling stockholder must agree to at the outset, are that the merger receive the approval of (1) an attentive Special Committee comprised of directors who are independent of the controlling stock­holder, fully empowered to decline the transaction and retain its own financial and legal advisors, and satisfies its duty of care in negotiating fair price, and (2) a major­ity of the unaffiliated stockholders, who are uncoerced in their vote and fully informed. Delaware courts require that these conditions be agreed to “at the outset” to ensure that controlling shareholders not use the MFW condi­tions as “bargaining chips” during economic negotiations, essentially trading price for protection. Controllers are thus motivated to maximize their initial offer if they want the immediate benefit of business judgment review.

Until the MFW decision, transactions that involved a con­trolling stockholder were always subject to the heightened, entire fairness level of review, which shifts to the controlling stockholder the burden to show that the transaction is fair to the minority stockholders and functionally precluded dismissal of a complaint at the pleadings stage.

An interesting question arose in Flood v. Synutra: what constitutes the beginning? In January 2016, Liang Zhang, who controlled 63.5% of Synutra’s stock, wrote a letter to the Synutra board proposing to take the company private, but failed to include the MFW procedural prerequisites of Special Committee and majority of the minority approvals in the initial bid. One week after Zhang’s first letter, the Synutra board formed a Special Committee to evaluate the proposal and, one week after that, Zhang submitted a revised bid letter that included the MFW protections. The Special Committee declined to engage in any price negotiations until it had retained and received financial projections from its own investment bank, and such ne­gotiations did not begin until seven months after Zhang’s second offer. Ultimately the board agreed to a deal.

Plaintiff Flood brought a lawsuit challenging the fairness of the price and asserting breach of fiduciary duties. Flood argued that because controller Zhang, who held 63.5% of the company’s stock, failed to propose inclusion of the MFW protections in his first offer (even though he did so shortly thereafter, before negotiations commenced), the transaction did not comply with MFW and still had to meet the “entire fairness” test.

The Delaware Supreme Court declined to adopt a “bright line” rule that the MFW procedures had to be a condition of the controller’s “first offer” or other initial communication with the target about a potential transaction. Rejecting this narrow reading of MFW, the Court clarified that the conditions need not be included in the initial overture but must be in place “at the beginning stage of the process of considering a going private proposal and before any negotiations commence between the Special Committee and the controller over the economic terms of the offer.” Thus, even if those protections were not included in the “first offer,” the key concern of MFW — “ensuring that controllers could not use the conditions as bargaining chips during economic negotiations”—would still be addressed if the protections were in place before any economic negotiations commenced. This more flexible approach in­centivizes controlling stockholders to pre-commit to these conditions, which in turn benefits minority stockholders.

Delaware Chancery Court Threatens the Future of Mandatory Arbitration Provisions


In March 2018, the United States Supreme Court in Cyan, Inc. et al. v. Beaver County Employees Retirement Fund (“Cyan”) held that state courts continue to have concurrent jurisdiction (along with federal courts) over claims alleging violations of the Securities Act of 1933 (the “1933 Act”). The 1933 Act most notably provides claims based on misrepresentations in initial public offering ma­terials. The holding in Cyan raised the prospect that such claims could be filed by different shareholders in different state and federal courts.

In response, many companies going public adopted provisions in their bylaws or charters designating federal courts as the exclusive forum for the resolution of claims against them under the 1933 Act. For example, twenty of the 241 companies that went public with offering sizes of at least $10 million that began trading between Jan. 1, 2017 and May 3, 2018, had provisions designating federal courts as the only forum for securities law complaints. By doing so, companies hoped to avoid state court litigation of 1933 Act claims, or to prevent concurrent litigation of identical cases in state and federal court. If all the claims were in federal courts, it would be possible to consolidate them in a single multi-district litigation.

In a recent, significant decision in Sciabacucchi v. Salzburg (“Blue Apron”), the Delaware Chancery Court refused to dismiss the action, and in the process refused to enforce three company charters mandating that federal district courts be the sole and exclusive forum for the resolution of complaints asserting violations of the 1933 Act.

Plaintiff, a shareholder of meal delivery service Blue Apron, Inc., streaming device maker Roku Inc., and online personal shopping service Stitch Fix. Inc., filed a complaint seeking declaratory judgment under the 1933 Act against twenty individuals who signed the allegedly misleading registra­tion statements for the companies and who have served as the companies’ directors since their respective public offerings.

The case came before the Chancery Court, a state court, on cross motions for summary judgment. The charters of the three companies, incorporated under the laws of Delaware, contained substantially the same federal forum provisions, which provided, in relevant part, that “the federal district courts of the United States of America shall be the exclusive forum for the resolution of any complaint asserting a cause of action arising under the Securities Act of 1933.”

Defendants argued that the Delaware General Corporation Law, which allows certain provisions for the “management of the business and for the conduct of the affairs of the corporation,” was intended to provide great flexibility in a corporation’s ordering of its affairs, including the adoption of forum selection provisions, so long as the provisions were not unreasonable or contrary to public policy. Ad­ditionally, defendants argued that the law’s provision precluding corporations from adopting provisions that prohibit bringing internal corporate claims in the State of Delaware did not apply, since claims arising under the 1933 Act were not based upon a violation of a duty by a current or former officer, director or stockholder in such capacity.

Relying, in part, on the 2013 Chancery Court’s landmark decision in Boilermakers Local 154 Ret. Fund v. Chevron Corp. (“Boilermakers”), plaintiff argued that exclusive forum provisions must be limited to internal corporate governance claims, which — by definition — excluded claims brought under the 1933 Act. Those, according to plaintiff, “ha[d] nothing to do with the corporation’s internal governance” and nearly always involve false statements made even before the plaintiff became a stockholder.

In a 56-page opinion, Vice Chancellor Laster sided with plaintiff, holding that the companies’ federal forum provi­sions were “ineffective and invalid,” on the grounds that “constitutive documents of a Delaware corporation cannot bind a plaintiff to a particular forum when the claim does not involve rights or relationships that were established by or under Delaware’s corporate law.” In so holding, Vice Chancellor Laster reasoned that although the state of incorporation has the power to regulate the corporation’s internal affairs — including the rights and privileges of shares of stock, the composition and structure of the board of directors, and what powers the board can exercise — the state cannot use corporate law to regulate the corpora­tion’s external relationships. Consequently, since a claim brought under the 1933 Act is external to the corporate contract, “corporate governance documents, regulated by the law of the state of incorporation, can[not] dictate mech­anisms for bringing … claims alleging fraud in connection with a securities sale.”

The Chancery Court’s decision in Blue Apron is one in a series of critical judicial pronouncements relating to the state courts’ jurisdiction over class actions alleging only 1933 Act violations by private plaintiffs.

If companies cannot force certain types of claims into federal court, can they force them into arbitration instead? A critical implication arising from the Chancery Court’s reasoning in Blue Apron is that provisions mandating arbitration of 1933 Act claims could also be deemed invalid. As partner Jennifer Pafiti wrote in the previous issue of The Pomerantz Monitor, “When it came to our attention that the United States Securities and Exchange Com­mission (the “SEC”) hinted that it might consider allowing companies to include mandatory arbitration clauses in their bylaws, Pomerantz acted quickly to express its con­cern that such clauses could eviscerate a shareholder’s ability to hold to account a corporate wrongdoer.” Pomerantz organized a coalition of large institutional investors from around the globe to meet with SEC Chair­man Jay Clayton in D.C. in October 2018, and also met with a number of both Republican and Democratic Senate staffers. Two weeks after these meetings, ten Republican State Treasurers, in a letter co-authored by the State Financial Officers Foundation, urged the SEC to maintain their existing stance against forced arbitration. Pomerantz has been credited by the American Association for Justice for our dedication to this effort.

On the other hand, proponents of mandatory arbitration clauses argue that such provisions are consistent with other litigation management tools that Delaware’s courts have recognized in the past, particularly in the Boilermakers case where the Chancery Court characterized compa­ny bylaw as a “flexible contract.” If the courts side with the consumers — a hypothesis that undoubtedly will be tested in litigation — corporations would be deprived of another vehicle by which they control the forum for resolution of claims arising under the 1933 Act. Most critically, it usually follows that if certain claims must be arbitrated, they cannot proceed as class actions.

If the Delaware Supreme Court affirms the Blue Apron decision, it could become a landmark.

Pomerantz: Securities Practice Group of 2018

Pomerantz earned a place on Law360’s coveted list of Securities Practice Groups of the Year for 2018. In its announcement, Law360 credited the firm’s stunning $3 billion win for investors in Petrobras securities as one of the reasons for this accolade. According to Law360, which interviewed Managing Partner Jeremy Lieberman pursuant to the award:

Pomerantz attorneys were able to achieve this re­sult, as well as an $80 million settlement resolving investor allegations involving Yahoo data breaches, by focusing much of their efforts on proving dam­ages, said managing partner Jeremy Lieberman. For the Petrobras case, investors ultimately alleged what they called an “unprecedented” 21 corrective disclosures revealing the fraud, and Lieberman said he personally spent about 500 hours with their damages expert.

“It was really understanding the damages and … putting defendants on the defensive and saying: Listen if you don’t pay us large settlements, you’re going to be in front of a jury and they’re not going to like to hear about some company involved in a mas­sive fraud and kickback scheme,” Lieberman said.

The Petrobras deal represented the biggest securities class action settlement in a decade and the big­gest-ever in a class action involving a foreign issuer, according to Pomerantz. … The class action settlement represented a 65 percent premium to the recoveries the individual plaintiffs secured, according to court documents.

“That’s really a unique, once-in-a-generation result where you’ll have the class do better than the opt-outs,” Lieberman said. “And it wasn’t by accident.”

Law360 further ascribed Pomerantz’s top standing to the precedent-setting rulings in Petrobras that the firm achieved in the Second Circuit Court of Appeals. The three-judge panel rejected Petrobras’ bid for a heightened standard when determining whether a class is ascertainable, or identifiable, and also rejected Petrobras’ argument that the investors should have been required to show that the stock increased in response to positive news and declined in response to negative news. As Jeremy Lieberman has stated, “These favorable decisions will form the bedrock of securities class action litigation for decades to come.”

Pomerantz Seeks Redress in Denmark for Danske Bank A/S Investors


Pomerantz has formed a coalition to seek redress in Denmark on behalf of investors who lost billions of dollars in the fallout from a €200bn money laundering scandal at Danske Bank A/S (“Danske” or the “Bank”). The coalition consists of the International Securities Associations & Foundations Management Company for Damaged Dan­ske Investors, LLC and Danish law firm, Németh Sigetty Advockater (“Németh Sigetty”). Németh Sigetty has a well-deserved reputation for handling major, complex, and high-stakes disputes against both private party litigants and government authorities and has vast experience with investor group litigations in Denmark.

Danske, Denmark’s largest bank and a major retail bank in Scandinavia and Northern Europe, had until recently enjoyed a reputation as one of Europe’s most respected financial institutions. Last year, Danske’s star swiftly fell, as media reports placed it at the center of one of the world’s largest and most egregious money laundering schemes.

On February 27, 2018, several newspapers revealed that Danske’s upper management had known about an extensive money laundering scheme and falsification of records at Danske’s Estonia branch since December of 2013, but had first concealed the misconduct and then misrepresented the extent of its participation in the money laundering scheme—all while touting Danske’s purported commit­ment to anti-money laundering policies and practices. The revelations emerged after a whistleblower had informed Danske that relatives of Russian President Vladimir Putin and high-ranking members of Russia’s Federal Security Service (the FSB, formerly the KGB) were behind one of the companies that were laundering money through the Bank’s Estonia branch. An internal audit at Danske had confirmed the accuracy of the whistleblower’s allegations as early as February 2014, and that Danske’s Board of Directors and Executive Board had been made aware of the audit’s conclusions. The Estonia Financial Supervisory Authority (“EFSA”) immediately announced an investigation to determine the Bank’s culpability in knowingly withhold­ing this information during prior EFSA inspections at the Estonia branch in 2014.

On April 5, 2018, Danske announced that Lars Morch, Danske’s Head of Business Banking, would be released from his ordinary work duties “as soon as possible,” but would remain formally employed at the Bank until October 2019. In announcing Morch’s release, Danske’s Board Chairman, Ole Andersen, stated that “the bank should have undertaken more thorough investigations at an earlier point,” which would have “prompted swifter actions.” On May 3, 2018, the Danish Financial Super-isory Authority (“DFSA”) issued its investigative report, which provided additional detail of stonewalling by the Bank’s central management.

On July 3, 2018, it was reported that the alleged money laundering volume at issue was approximately $8.3 billion, much larger than the earlier estimate of $1.5 billion. Two weeks later, Danske announced that it had made an estimated profit as high as $234 million in connection with the suspicious transactions, and that it would forego the illicit profit.

On September 7, 2018, The Wall Street Journal reported that Danske was conducting a probe of transactions subject to money laundering concerns and that the value of the suspicious transactions under review might be as high as $150 billion. Then, on September 19, 2018, Danske issued a report documenting the results of its internal investigation, which con­firmed the knowledge and complicity of Danske’s senior management in covering up the money laundering scheme at the Bank’s Estonia branch. The report added key details to previous news reports, and also disclosed that the cash flows through the Estonia branch’s Non-Resident Portfolio were much higher than previous estimates, amounting to approx­imately $234 billion worth of transactions bearing the suspicious hallmarks of money laundering activity.

Since the initial disclosure of the money laundering scheme and Danske’s management’s role in concealing it, Danske’s stock price has fallen from 250.10 DKK 122.00 DKK at the time of this writing, representing a total loss of more than 86 billion DKK, or nearly $13 billion, in market capitalization. Criminal investigations are currently pro­ceeding against Danske and members of its management in France, Denmark, the United Kingdom, the United States, and Estonia. In November 2018, Danske was formally charged by the Danish Prosecutor for money laundering-related violations.

Generally speaking, Danish group actions proceed on an opt-in basis, in which a group representative is appointed by the court to represent the group’s interest. Under Denmark’s legal regime, the “loser” is typically required to pay the legal costs of the prevailing party. However, Pomerantz has organized to bring a group action in Denmark in which all legal fees and any adverse costs for which an investor could otherwise become liable be borne by litigation funders and/or other parties. This means that there is no downside financial risk for any inves­tor with respect to costs by participating. Pomerantz will work in conjunction with Danish counsel with respect to its clients, overseeing and operating in a supervisory role with respect to their claims.

The process to recover losses requires damaged investors to proactively join an organized litigation “group” which will aggregate each investor’s loss into a collective loss in a single claim and action before the Danish Court. Németh Sigetty will file this group litigation on behalf of eligible investors organized via Pomerantz’s coalition in the second quarter of 2019. Only those investors who are named as participants will be able to benefit from any settlement or judgment.

Pomerantz Hosts International Conference in New York


On October 23, Pomerantz hosted its 2018 Corporate Governance and Securities Litigation Roundtable Event in the Four Seasons Hotel in New York City. The Round­table Event provides institutional investors from around the globe with the opportunity to discuss topics that affect the value of the funds they represent, and to net­work with their peers in an informal and educational setting. Presenters are international experts in the fields of corporate governance, securities litigation and asset management. This year, presenters and attendees trav­eled to the Roundtable from across the United States, the United Kingdom, France, Italy, Belgium, and Israel.

The theme of this year’s Roundtable Event focused on women and minorities who have risen through the ranks and have pioneered the path for change and unity in our communities. Pomerantz Partner Jennifer Pafiti, the event’s organizer, says, “We were excited to present is­sues of importance to institutional investors through the lens of diversity. Judging by the robust exchange of ideas during the day’s sessions and the feedback we have re­ceived, these are matters that resonate globally today.” As a first-year associate with Pomerantz, and as a wom­an with an ethnically diverse background, creating and participating in this event was a great point of pride and honor in my career. While our community is at the cusp of change, Pomerantz believes it is pivotal to be at the fore­front to encourage these discussions to further educate and bring awareness to ourselves and members of our community with the hope of encouraging and fostering a change that will benefit us all.

Counsel to a $400-billion European asset management company presented, “Corporate Governance: What Can the World Learn from the European Model?” This session explored the emerging European corporate governance model, and how it compares to its Anglo-American coun­terpart. The European Union’s 2017 Shareholder Rights Directive (“SRD”) mandates that institutional investors and asset managers develop and publicly disclose an engagement policy that describes, among other matters, how they integrate shareholder engagement in their in­vestment strategy, and how they monitor investee com­panies on relevant matters, including ESG: environmen­tal, social, and corporate governance. Of interest to many in the room was the news that the United States receives a relatively low ESG country rating in the EU for the rea­sons that it pulled out of the Paris Agreement on climate change and maintains the death penalty.

“Gunning for Profit” was another session that focused on ethical investing. Following a number of mass shootings in the United States, CalSTRS made the decision to stop investing in companies that sold assault-style weapons or devices that allow guns to fire more rapidly. The ses­sion inspired a lively discussion on whether ethical in­vesting makes financial sense, and provided insight into why CalSTRS, the second-largest pension fund in the U.S., decided to take a stand against the big guns.

The Roundtable Event also discussed the allegations against Harvey Weinstein and how they created a Hol­lywood movement that has since gained momentum around the globe, turning the focus to workplace culture and corporate governance. Beyond Weinstein’s liability, the conversation has since turned to the institutions that allowed those crimes to become a part of the corporate culture. The panel session, “Corporate Governance in a Post-Weinstein Era” addressed such issues. Among other information shared by panelists, Partner Gustavo Bruckner, who heads Pomerantz’s Corporate Gover­nance litigation team, described the firm’s involvement in current litigation relating to sexual and other harass­ment in the workplace (see his article in this issue of the Monitor).

Research indicates that companies with board members representing diversity of thought and culture deliver high­er returns on equity and better growth overall. In the past five years, many countries have passed legislation man­dating diverse board representation or set non-mandato­ry targets. However, some argue diversity cannot be truly measured and performance cannot be attributed to the makeup of those occupying boardroom seats. The panel “Diversity in the Boardroom: Fashion or Fact?” opened up vibrant debate among panelists and Roundtable at­tendees as it explored those conflicting ideals, how sub­conscious bias can affect selection processes, and why diversity in the boardroom should foster an environment in which every shareholder is represented.

In “Unleash the Lawyers: Securities Litigation Policy and Practice,” a panel of lawyers shared their thoughts on the hallmarks of a robust securities litigation policy and what to do to mitigate a fund’s liability in the absence of one.

Jeremy Hill, Group General Counsel for Universities Su­perannuation Scheme (“USS”), gave an enlightening pre­sentation on USS’s role as lead plaintiff in the Petrobras litigation, in which USS and Pomerantz recently achieved a historic settlement of $3 billion on behalf of defrauded investors with Brazilian oil giant, Petrobras, and its audi­tors. Armed with candor, facts, and figures, he explained how a conservative British pension fund that had never before served as lead plaintiff found itself leading the highest-profile class action in the United States.

Pomerantz Co-Managing Partner Jeremy Lieberman spoke on, “Will Trump’s SEC Negate Investors’ Ability to Fight Securities Fraud?” With serious indications that the new SEC Chair, Jay Clayton, is considering allowing corporations to use forced arbitration clauses to curtail investors’ rights to bring securities class actions, Jeremy used several examples from Pomerantz’s roster of ac­tive and recently settled cases to demonstrate the very real and deleterious effect that forced arbitration would have on investors. He also addressed what institutional investors can do to protect their right to hold companies accountable for securities fraud. Notably, the day after the Roundtable, Jeremy Lieberman and Jennifer Pafiti traveled to Washington D.C. to meet with Chairman Clay­ton and other key Senate staffers to strenuously argue against forced arbitration clauses and for the crucial func­tion of securities class action litigation as a fundamen­tal principal to hold corporate wrongdoers accountable. [Eds.’ note: See cover story for the update.]

The Pomerantz Monitor will keep our readers posted on the next Corporate Governance and Securities Litigation Roundtable Event, scheduled for 2020 in California.

California Champions Women for Board Seats


In late September, California became the first state to re­quire its publicly held corporations to include women on their boards. Pursuant to this new law, SB-826, publicly traded corporations headquartered in California must have at least one woman on their boards of directors by the end of 2019. By the end of July 2021, a minimum of two women must sit on boards with five members, and there must be at least three women on boards with six or more members. Companies that fail to comply face fines of $100,000 for a first violation and $300,000 for a second or subsequent violation.

It is widely accepted that companies with gender-diverse boards of directors outperform their peers. Although it is not uniformly settled as to why this is so, companies with gender-diverse boards tend to have higher returns on eq­uity and net profit margins than their peers. Studies have shown that the greatest benefit to a company’s bottom line occurs when there are three or more women on a board. According to one famous study, “One female board mem­ber is often dismissed as a token. Two females are not enough to be taken seriously. But three give the board a critical mass and the benefit of the women’s talents.”

In the United States, women comprise about half of the total workforce; hold half of all management positions; are responsible for almost 80% of all consumer spending; and account for 10 million majority-owned, privately-held firms, employing over 13 million people and generating over $1.9 trillion in sales.

It is generally believed that gender diversity on boards translates to less “group think,” greater expression of non-conforming views, more leadership positions for tal­ented but often overlooked female employees, and less tolerance for underperforming CEOs.

Every company but one on the Standard & Poor’s 500 has at least one woman on its board and 11 of the Standard & Poor’s 500 companies, including Best Buy, Macy’s, Viacom and General Motors, have half or more of their board seats held by women. However, women still only hold 19.9% of board seats at Standard & Poor’s 500 companies.

Sixty-four countries have made some sort of national effort to promote boardroom gender diversity. In 2003, Norway passed a law mandating 40 percent representation of each gender on the board of publicly limited liability companies. Since then, approximately 20 countries have adopted some sort of legislation/quota to increase the number of women on boards, including Colombia, Kenya, Belgium, Denmark, Finland, France, Germany, Iceland, Italy, and Israel. Not surprisingly, a study of global companies found that Norway (46.7%) and France (34.0%) had the highest percentages of women on their boards.

In the United States, there has been a deep reluctance to mandate gender quotas. The Securities Exchange Com­mission (SEC) requires that companies disclose whether they have a diversity policy, and how it applies to board recruitment practices (Regulation S-K, Item 407(c)). While the SEC recommends that this include “race, gender, and ethnicity of each member/nominee as self-identified by the individual,” ultimately, the definition of diversity is left to each issuer. Many states have passed resolutions encour­aging public companies to gender diversify their boards. Some, like Rhode Island, made pension fund investments conditional on increased board diversity. In March, the New York State Common Retirement Fund said it would vote against all corporate boards of directors standing for re-election at companies with no women board members. The California State Teachers’ Retirement System recent­ly sent letters to 125 California corporations with all-male boards warning them that they risk shareholder action if they do not self-diversify. Thirty-five of those companies subsequently appointed female directors.

The political forces in California felt that change was not being effected fast enough. A quarter of California’s public­ly traded companies do not have a woman on their boards and there are 377 California-based companies in the Rus­sell 3000 stock index of large firms with all-male boards that could be affected by the new law. 684 women will be needed to fill board seats for Russell 3000 companies by 2021.

Hare-Brained Tweet gets Musk in Trouble


On September 27, 2018, the SEC sued Elon Musk, CEO and Chairman of Tesla Inc., charging him with securities fraud. It alleged that on August 2, 2018, after the close of the market, Musk had sent an email with the subject, “Offer to Take Tesla Private at $420,” to Tesla’s Board of Directors, Chief Financial Officer, and General Counsel. Musk stated he wanted to take Tesla private because being a publicly-traded company “[s]ubjects Tesla to con­stant defamatory attacks by the short-selling community, resulting in great harm to our valuable brand.” Apparently Musk had not lined up financing or done any other prepa­ratory work before making this offer.

Before anyone at the company could respond, on August 7, 2018 Musk sent out a series of false tweets about the potential transaction to take Tesla private, confusingly saying that:

“My hope is *all* current investors remain with Tesla even if we’re private. Would create special purpose fund enabling anyone to stay with Tesla.”

“Shareholders could either to [sic] sell at 420 or hold shares & go private.”

“Investor support is confirmed. Only reason why this is not certain is that it’s contingent on a share­holder vote.”

Rule 10-b5 prohibits a company’s officers and directors from “knowingly or recklessly mak[ing] material misstate­ments about that company.” Musk’s tweets contain both clearly factual statements that are ambiguous or incom­plete at best and concern information that Tesla share­holders would find very important.

The SEC’s complaint alleged that Musk had not even discussed the deal terms he tweeted, which offered a substantial premium to investors that was greater than Tesla’s share price at the time. After the tweet, Tesla’s stock price rose on increased trading volume, closing up 10.98% from the previous day.

A press release issued by the SEC on September 27, 2018 made it clear that Musk’s “celebrity status,” includ­ing his 22 million Twitter followers, did not affect his “most critical obligations” as a CEO not to mislead investors, even when making statements through non-traditional media. This status and Musk’s large audience drove the tenor of the SEC’s complaint and the relief sought: a permanent injunction against future false and misleading statements, disgorgement of any profits resulting from the tweets, civil penalties, and a bar prohibiting Musk from serving as an officer or director of a public company.

The SEC had previously issued a report that companies can use social media to announce key information in compliance with Regulation Fair Disclosure, so long as investors have been alerted about which media avenues will be used and such statements otherwise comply with regulations. This clarification arose out of the 2013 in­quiry into a post by Netflix CEO Reed Hastings’ person­al Facebook page, stating that Netflix’s monthly online viewing had exceeded one billion hours for the first time. Due to the uncertainty about the rule, an enforcement action was not initiated regarding Hastings or Netflix.

Regarding the disclosure of material, company-specific information via Twitter, the SEC averred that Tesla had stated in 2013 that the company may use social me­dia to release information to investors, but never made any greater specification. Here, Musk announced a re­cord-breaking private buyout offer at a price he alone determined without any board approval or arms-length negotiation.

Musk initially rejected settlement negotiations outright, but lawyers for the company purportedly convinced him, and the SEC, to come back to the table. Before Musk or Tesla responded to the SEC’s complaint, settlement was quickly reached on September 29, 2018 and a joint motion for the court to approve the settlement was filed. The deal allows Musk to remain CEO and a board mem­ber but imposed a two-year ban as Chairman and a $20 million fine, as well as a $20 million fine on Tesla. The settlement further requires Tesla to add two independent directors as well as a permanent committee of indepen­dent directors tasked with monitoring disclosures and potential conflicts of interest. Such monitoring includes a required preapproval of any communications regard­ing Tesla in any format that contains, “or reasonably could contain, information material to the Company or its shareholders.”

On October 4, District Judge Alison J. Nathan ordered the parties to file a joint letter explaining why the proposed settlement was fair and reasonable, which was filed Oc­tober 11. As to the reasons behind the tweets, Musk has cryptically commented, “[i]f the odds are probably in your favor, you should make as many decisions as possible within the bounds of what is executable. This is like be­ing the house in Vegas. Probability is the most powerful force in the universe, which is why the house always wins. Be the house.”

Before the Court ruled on the proposed settlement, Musk released another confusing tweet:

“Just want to [sic] that the Shortseller Enrichment

Commission is doing incredible work. And the name change is so on point!”

The court nevertheless overlooked this outburst, ap­proved the settlement and entered final judgment on October 16. After taking a short Twitter break, Musk then tweeted that the whole debacle was “[w]orth it.”

The settlement comes without an admission or denial of wrongdoing by Musk, but stands as a clear reminder of the obligations that the officers and directors of public companies have to shareholders. Tesla is a company whose value is in no small part its future potential – a value driven by a belief that Musk is central to the com­pany’s ongoing success. It appears as though this was tacitly recognized through the settlement negotiations, as the second round resulted in the SEC backing away from their initial position that Musk be barred from being a corporate officer or director permanently. Such a pun­ishment could have easily proved ruinous for Tesla.

In a time where even presidential communiqués can issue via Twitter, officer and director statements con­cerning material information related to publicly traded companies must adhere to the well-established rules of disclosure, even when they are limited to 140 characters or less.

Protecting Shareholder Rights: Forcing Away Forced Arbitration Clauses


Pomerantz is the oldest law firm in the world dedicated to representing defrauded shareholders. When it came to our attention that the United States Securities and Exchange Commission (the “SEC”) hinted that it might consider allowing companies to include mandatory arbitration clauses in their bylaws, Pomerantz acted quickly to express its concern that such clauses could eviscerate a sharehold­er’s ability to hold to account a corporate wrongdoer.


Banks, credit card issuers and other companies, preferring to settle disputes with shareholders without going to court over class action lawsuits, often insert mandatory arbitra­tion/class action waiver provisions in the fine print of their service agreements. But for investors, a bar on securities class actions would eliminate the ability of all but the largest shareholders to seek compensation from compa­nies who have violated U.S. securities laws.

For decades, it has been the policy of the SEC not to ac­celerate any new securities registrations for companies that contained a class action waiver provision, as such waivers run counter to the SEC’s mission to enforce the federal securities laws. In 2012, the Carlyle Group’s Initial Public Offering registration was delayed because it con­tained such a waiver bylaw. Ultimately, under pressure to complete its offering, the Carlyle Group scrapped the offensive waiver. Since then, no public company has at­tempted to include such a waiver bylaw in its registration statement, preserving the right of defrauded investors to participate in securities class actions.

Then last year, a Consumer Financial Protection Bureau rule banning mandatory arbitration was overturned by the Republican-controlled Congress, under the Congres­sional Review Act. President Donald Trump signed the legislation, H.J. Res. 111 (115).

Adding concern is a recent push by the U.S. Chamber of Commerce and other affiliated groups to allow forced arbitration clauses. At a Heritage Foundation conference in July 2017, then Republican SEC Commissioner Michael Piwowar openly encouraged corporations to file registration statements containing class action waiver bylaws. In October 2017, the U.S. Treasury Department issued a position paper whereby it encouraged the SEC to change its policy regarding class action waivers. A few months ago, Republican Commissioner Hester Peirce answered “absolutely” to the question as to whether she believed such bylaws should be allowed.

The position today is that unless the cur­rent Chairman of the SEC, Jay Clayton, is convinced to maintain the status quo, the SEC can and will easily change its policy to allow class action waiver bylaws, which would doom investors’ rights to hold corporate wrongdoers accountable via securities class actions in the U.S.

Hear Us Roar:

To express concerns over a potential shift in policy, Pomerantz organized a coalition of large institutional investors from around the globe to meet with SEC Chairman Jay Clayton in D.C. on October 24, 2018. The key focus of this meeting was to attempt to persuade Chairman Clayton against the recent push by the U.S. Treasury Depart­ment and the Republican Commissioner of the SEC to allow for forced arbitration/class action waiv­er bylaws which could seriously undermine the future of defrauded investors.

Wanting to make sure all bases were covered, and after meeting with Chairman Clayton, Pomerantz and the team of institutional investors then met with a number of both Republican and Democratic Senate staffers. The purpose of the meetings was to encourage them, in particular Republican Senators, to write to Chairman Clayton cautioning against a shift in policy that would impose forced arbitration bylaws on investors.

Our Voices Were Heard:

On November 13, 2018 – two weeks after the SEC meetings – ten Republican State Treasurers, in a letter co-authored by the State Financial Officers Foundation, urged the SEC to maintain their existing stance against forced arbitration. In the letter, the State Financial Officers Foundation, which represents mostly conservative-lean­ing state treasurers, auditors and controllers, expressed “concerns about recent news reports that the SEC may change its long-standing position and allow public companies to include forced arbitration clauses in their corporate governance documents.” The letter went on to say that: “Allowing public companies to impose a private system of arbitration on investors “will eliminate the ability of all but the largest shareholders to seek recompense from criminals.” Republican Treasurers signing the November 13 letter represent Arizona, Arkansas, Idaho, Indiana, Kentucky, Louisiana, Maine, Nevada, South Carolina and Washington State. It is a significant and unusual step to have ten Republican Treasurers publicly take a position contrary to two Republican SEC Commissioners and the Treasury Department.

Pomerantz has been credited by the American Association for Justice for our dedication to this effort.

Jeremy Lieberman, Pomerantz’s Co-Managing Partner, said of the firm’s efforts on this matter: “Bringing a coalition of large institutional investors from around the globe to ex­press our concern to Chairman Clayton is an important step to ensuring the continued viability of shareholder litigation for institutional and retail investors. While we be­lieve that Chairman Clayton was receptive to our position, it is critical to continue a full court press to ensure that both Congress and policy makers understand the significance of this issue to the investor community.”

Looking Ahead:

Democrats remain concerned about mandatory arbitration and the issue is likely to get renewed attention when the party takes control of the House in January.

Rep. Carolyn Maloney of New York, currently the Dem­ocratic head of the House panel that oversees the SEC, said in April that “allowing companies to use forced arbi­tration clauses would devastate investor confidence in our markets.”

While the Republican letter to the SEC is a strong step for­ward, the institutional investor community should remain concerned about any SEC shift in policy. Pomerantz will continue to work proactively with the institutional investor community to prevent a policy change that would harm institutional investors.

Ninth Circuit Slams Overuse of "Judicial Note" and "Incorporation by Reference" on Motions to Dismiss


Therapeutics, a securities case, put the spotlight on a tactic defendants have long overused in support of their motions to dismiss. On such motions, district courts, in deciding whether the complaint states a legal claim for relief, are required to accept plaintiffs’ well-pled allegations as true. Increasingly, defendants have sought an end-run around that requirement, routinely requesting that the court accept, as true, documents outside of the complaint which, they claim, disprove plaintiffs’ allegations. They invoke the doctrines of judicial notice and incorporation by reference to place this extrinsic evidence before the court for the purpose of disputing plaintiffs’ allegations and providing the court with their own version of the facts.

This practice may change, thanks to the detailed 59-page ruling by the Ninth Circuit in Orexigen, which condemned the “unscrupulous use of extrinsic documents to resolve competing theories against the complaint.” Such tactics “can undermine lawsuits and result in premature dismissals of plausible claims that may turn out to be valid after discovery.” The Ninth Circuit observed that this risk is especially significant in securities fraud cases, where there is a heightened pleading standard and the defendants possess materials to which the plaintiffs do not yet have access.

The court reversed the district court’s order dismissing the complaint, holding that the lower court had abused its discretion by judicially noticing two of the documents and incorporating by reference seven documents, and by considering statements in those documents as being true. The main takeaway for investors is the Ninth Circuit’s recognition of the improper use of judicial notice and incorporation by reference, which the panel admonished.

Courts may take judicial notice of undisputed matters of public record to the extent permitted by Rule 201 of the Federal Rules of Evidence. Judicial Notice is appropriate for the limited purpose of noting that the statements were actually made at the time and in the manner described in the complaint. But judicial notice is not appropriate for the purpose of determining the truth of any of those statements.

Here, the Ninth Circuit found that the district court abused its discretion by judicially noticing two exhibits attached to Orexigen’s motion to dismiss and, more importantly, by accepting as true various assertions in those documents. Those documents were an investor conference call transcript submitted with one of Orexigen’s Security and Exchange Commission (SEC) filings, and a report issued by the European Medicines Agency (EMA). Generally, documents filed with the SEC and documents issued by a governmental agency may be judicially noticed because they are from sources whose accuracy cannot reasonably be questioned. But, the Ninth Circuit importantly noted that accuracy is only one part of the inquiry under Rule 201(b) – a court must also consider and identify which facts it is accepting as true from such a transcript. Just because the document itself is susceptible to judicial notice does not mean that every assertion of fact within that document must be accepted, as is true on a motion to dismiss. The Ninth Circuit held that reasonable people could debate what the conference call and EMA report disclosed or established. Therefore, the Ninth Circuit found that to the extent the district court judicially noticed the identified facts on the basis of the investor call transcript and report, it had abused its discretion.

The doctrine of incorporation by reference permits a district court to consider, as part of the complaint itself, documents whose contents are alleged in the complaint and whose authenticity no party questions. The doctrine prevents plaintiffs from, for example, selectively quoting parts of documents in their complaint, or deliberately omitting references to documents upon which their claims are based. Defendants are allowed to correct such allegations by demonstrating what the operative documents actually say.

However, there are limits to the application of the incorporation by reference doctrine. First, the complaint must refer “extensively” to the document in question; a passing reference will not justify bringing the whole document into the record on the motion. Second, as an alternative, defendants may establish that a particular document, whether referenced in the complaint or not, may be incorporated if it actually forms the basis of the plaintiff’s claim.

But, what this doctrine clearly cannot permit, according to the Ninth Circuit, is defendants introducing a document that is not mentioned in the complaint or that does not necessarily form the basis of the complaint to merely create a defense to the well-pled allegations in the complaint. If this is permitted, then defendants would, in effect, be disputing the factual allegations in the complaint and thereby circumventing the rule requiring alleged facts in complaints to be accepted as true at the pleading stage. And, if the district court does not convert the motion to dismiss into a motion for summary judgment, which would provide both sides an opportunity to introduce evidence regarding the factual allegations, then plaintiffs would be left without an opportunity to respond to the new version of the facts, making dismissal of otherwise cognizable claims very likely.

Perhaps the most important limitation on the incorporation by reference doctrine is that while this doctrine, unlike judicial notice, permits courts to assume an incorporated document’s contents are true for purposes of a motion to dismiss under Rule 12(b)(6), it is improper to assume the truth of an incorporated document if such assumptions only serve to dispute facts stated in a wellpled complaint. This is consistent with the prohibition against resolving factual disputes at the pleading stage.

As the Ninth Circuit correctly noted, judicial notice and incorporation by reference do have roles to play at the pleading stage. It is the overuse and improper application of the doctrines that can lead to unintended and harmful results. During oral argument in the Orexigen appeal, Judge Berzon asked defense counsel, “[T]here are all of these judicially noticed and incorporated documents, do any of them matter…we are turning these things into summary judgment proceedings – why don’t we just stick to the complaint?” These are apt and fundamental questions. Hopefully, this decision will help tip the scale back in the direction of identifying the documents outside the complaint that actually matter and ensuring that they are applied correctly so that potentially meritorious claims have a fighting chance of surviving motions to dismiss.

Supreme Court Rules on SEC Administrative Law Judges


Like many federal agencies, the SEC uses administrative law judges (“ALJs”) to hear and render initial decisions on administrative cases brought by the agency. Up until now the SEC has considered these ALJs to be “employees” who could be hired and fired by agency staff.

On June 21, 2018, in Lucia v. SEC, the United States Supreme Court upended that practice, holding that the SEC’s ALJs are not mere employees but are actually “inferior officers” of the United States, subject to the Appointments Clause of the United States Constitution. The Supreme Court’s ruling means that going forward, ALJs must be appointed by the President, “Courts of Law,” or “Heads of Departments.”

The case reached the Supreme Court after an SEC ALJ rendered an unfavorable decision against Raymond Lucia, a financial radio host and investment adviser known for his “buckets of money” investment strategy. The unfavorable decision, under the Investment Advisers Act, banned Lucia from the industry and charged him a $300,000 fine. Lucia appealed within the SEC (and later to the D.C. Circuit) arguing that the administrative proceeding was invalid because the presiding ALJ had not been constitutionally appointed and thus lacked the constitutional authority to do his job. The Trump Administration sided with Lucia, reversing the position previously taken by the Obama administration that ALJs are not inferior officers.

Justice Kagan, writing for the majority and relying on three Supreme Court cases, explained that the ALJ’s are “inferior officers” because they hold a “continuing office established by law,” and “exercise significant authority pursuant to the laws of the United States” in carrying out “important functions,” which include adjudicating administrative decisions. The Court found its previous decision in Freytag v. Commissioner particularly compelling. There, the Supreme Court held that Special Trial Judges (“STJ”) in the United States Tax Court were “officers” for purposes of the Appointments Clause. The Supreme Court found that the SEC’s ALJs are nearly carbon copies of the STJs, except that the STJs must have their decisions adopted by a regular judge. An ALJ’s decision, on the other hand, only becomes final when the SEC declines review. “That last-word capacity makes this an a fortiori case: If the Tax Court’s STJs are officers, as Freytag held, then the Commission’s ALJs must be too.”

Notably, the SEC had already abandoned its position that ALJs were “employees” back in November 2017 (though after Lucia’s enforcement action) and ratified the prior hiring of its ALJs in a manner it deemed consistent with the Appointments Clause. The Supreme Court ruled on the issue anyway, concluding not only that Lucia is entitled to a new hearing before a properly appointed official, but also that this official cannot be the ALJ who previously heard the enforcement action, even if that particular ALJ “has by now received a constitutional appointment.” The Court did not rule on whether the SEC’s ratification of the prior hires was sufficient to satisfy the Appointments Clause.

On August 22, 2018, the SEC issued an order (the “Order”) lifting a stay it had imposed on June 21, 2018, in reaction to the ruling in Lucia on “any pending administrative proceeding initiated by an order instituting proceedings that commenced the proceeding and set it for hearing before an [ALJ], including any such proceeding currently pending before the Commission.” The Order also reaffirms the SEC’s November 30, 2017 order ratifying the constitutional appointment of certain ALJs; grants all respondents in the newly un-stayed proceedings the “opportunity for a new hearing before an ALJ who did not previously participate in the matter”; and remands all cases pending before the SEC to the Office of the ALJs “for this purpose.” Moreover, the Order vacates “any prior opinion” the SEC has issued in nearly 130 pending matters. The day after issuing the Order, Chief ALJ Brenda P. Murray confirmed that another nearly 70 cases pending before ALJs prior to the Order would be reheard, pursuant to the Order. As a result, parties who received a negative initial decision from an ALJ prior to the SEC’s ratification order but have not yet exhausted their appeal, now have the chance for a completely new hearing before a different ALJ. Parties who do not wish to have a new hearing in front of a fresh ALJ were required to notify the Chief ALJ by September 7.

This decision leaves open several questions, including the constitutionality of the SEC’s ratification order; the extent to which this ruling will apply to other agencies like the CFPB and the FDIC; and the degree to which political influence can and will be exerted in the ALJ appointment process.

Toshiba: Ninth Circuit Applies Morrison Two Prong Test

ATTORNEY: Jessica N. Dell

In July the Ninth Circuit issued an important decision that reversed the dismissal of U.S. investors’ securities fraud claims against Toshiba, in Stoyas v. Toshiba Corp.

The case arose from revelations that Toshiba had overstated profits by $2.6 billion. Toshiba was fined a record $60 million by Japanese securities regulators, and Toshiba’s CEO resigned amidst the scandal. When the market discovered the fraud, the value of both Toshiba’s own stock, and the ADRs, plummeted. The U.S. investors’ dilemma was that while it was Toshiba that had committed the fraud, it was the banks, and not Toshiba, that had sold the Toshiba ADRs in the U.S.

Toshiba is a Japanese corporation whose common shares are listed and traded on the Tokyo Stock Exchange; they are not registered with the SEC or listed on any U.S. exchange. In this case, U.S. investors purchased “unsponsored” American Depositary Receipts (“ADRs”) for Toshiba shares over-the-counter in the U.S.

ADRs are a way for U.S. investors to purchase stock in foreign companies. ADRs are securities, denominated in U.S. dollars; the underlying security is bought on the foreign exchange by a bank and is held by that bank overseas. ADRs are said to be “sponsored” if the issuer takes a formal role with the bank creating the ADRs; unsponsored ADRs are created without much, if any, involvement by the issuer. Toshiba did not even have to register its securities with the SEC to allow the creation of the ADRs. The banks then arranged for these ADRs to trade over-the-counter in the U.S.

The principles to be applied here were established in 2010 by the Supreme Court in Morrison v. National Australia Bank. There the Court held that, while there is a presumption that the U.S. securities laws do not apply to overseas conduct of foreign companies, U.S. securities laws could be applied to transactions in a foreign company’s securities if that company’s shares are listed on U.S. domestic exchanges, or are “otherwise traded” in the U.S.

In dismissing the Toshiba case in 2016, the district court had held that 1) the over-the-counter market, where Toshiba ADRs are traded, is not a “domestic exchange”; and 2) that the ADRs are not “otherwise traded in the U.S.,” under Morrison, because even if the shares were actually bought in the U.S. Toshiba had no direct connection to those transactions. The district court concluded that “nowhere in Morrison did the Court state that U.S. securities laws could be applied to a foreign company that only listed its shares on foreign securities exchanges but whose stocks are purchased by an American depositary bank on a foreign exchange and then resold as a different kind of security (an ADR) in the United States.”

The Ninth Circuit held that plaintiffs could well be able to plead a viable claim under U.S. securities laws, and granted them leave to amend their complaint in the action in order to do so. Applying Morrison’s two prong test, it agreed with the District Court that the over-the-counter market was not an “exchange,” and that therefore the first prong of Morrison was not satisfied. But it disagreed with the lower court on whether the Toshiba ADRs were “traded in the U.S.” It held that, for U.S. securities laws to apply under Morrison’s second prong, plaintiffs needed to establish only that they purchased the Toshiba ADRs in U.S. domestic transactions. It held that it was the location of the sales, and not the identity of the participants in those sales, that was important. It recognized that, to prevail in the case, plaintiffs would ultimately have to plead, and prove, facts showing that Toshiba had committed fraud “in connection with” the U.S. sales of the ADRs. But it determined that the fact that Toshiba was not a participant in the U.S. sales is not controlling on whether the securities laws applied in the first place:

Specifically, Toshiba argues that because the [investors] did not allege any connection between Toshiba and the Toshiba ADR transactions, Morrison precludes the Funds’ Exchange Act claims. But this turns Morrison and Section 10(b) on their heads: because we are to examine the location of the transaction, it does not matter that a foreign entity was not engaged in the transaction. For the Exchange Act to apply, there must be a domestic transaction; that Toshiba may ultimately be found not liable for causing the loss in value to the ADRs does not mean that the Act is inapplicable to the transactions.

The court held that under the standard “irrevocable liability” test, the transaction occurs wherever the parties incur irrevocable liability” to buy or sell the shares. Noting that the plaintiffs’ transactions in the Toshiba ADRs have many connections to the United States, the court determined that “an amended complaint could almost certainly allege sufficient facts to establish that [the plaintiffs] purchased [their] Toshiba ADRs in a domestic transaction” in light of the “irrevocable liability” standard. Among the numerous connections to the United States they identified: the plaintiffs are U.S. entities located in the U.S., the ADRs were purchased in the U.S. and traded over-the-counter on a platform located in the States, and the depository banks that host ADR trading are located in the U.S.

In reaching this conclusion, the Ninth Circuit rejected Toshiba’s (and the district court’s) reliance on the Second Circuit’s Parkcentral Global Hub ruling, in which that court said that domestic transactions are not sufficient to establish the applicability of the U.S. securities laws under Morrison, and that some participation or involvement by the issuer in those transactions is required. The appellate court said Parkcentral is distinguishable and that Parkcentral’s test for whether a claim is “so predominately foreign as to be impermissibly extraterritorial” is an “open ended, under-defined, multi-factor test, akin to the vague and unpredictable tests that Morrison criticized and endeavored to replace.” The court likewise rejected the argument that allowing the securities laws to apply to ADRs would undermine principles of comity, holding that “it may very well be that the Morrison test in some cases will result in the Exchange Act’s application to claims of manipulation of share value from afar.”

By rejecting the holding of Parkcentral, the Ninth Circuit in Toshiba created a circuit split that could lead to a Supreme Court cert petition.

While there is no guarantee that the purchasers of the Toshiba ADRs will prevail in their next round of pleadings, the new decision showed that even a foreign company without any obvious participation in U.S. Securities transactions may still be subject to U.S. law if the pleadings show the misconduct was “in connection” with the purchase or sale in the U.S. It has, at least for now, defanged the arguments that any and all attempts at recovery by holder of unsponsored ADRs would per se be blocked by Morrison.

Judge Kavanaugh and the Impending Lorenzo Case Before the Supreme Court

ATTORNEY: J. Alexander Hood II

Several years ago, in Stoneridge Partners, Pomerantz persuaded the Supreme Court to rule that people who engage in schemes to defraud can be liable for securities fraud, even if they themselves made no misstatements to investors, under a theory known as “scheme liability.”  

On June 18, the Supreme Court granted certiorari in SEC v. Lorenzo, which presents the question of where the boundaries are between scheme liability (which is actionable) and aiding and abetting (which is not). The D.C. Circuit had affirmed the SEC’s imposition of sanctions against Lorenzo under scheme liability. Dissenting in that case was Circuit Judge Brett Kavanaugh, President Trump’s pending nominee for the Supreme Court.  

Unlike Justice Gorsuch, whose hostility towards securities law enforcement has been well documented, Judge Kavanaugh has had relatively few opportunities to rule on securities fraud cases, which are typically litigated in the judicial district in which the defendant company is headquartered. Accordingly, his judicial paper trail is less than illuminating with respect to some of the legal questions most frequently at issue in those cases. However, a review of his 2017 dissent in Lorenzo v. SEC suggests that a Justice Kavanaugh would try to define scheme liability out of existence.  

Lorenzo concerns communications by Francis Lorenzo, the director of investment banking at Charles Vista, LLC, a registered broker-dealer, to potential investors, concerning the company Waste2Energy Holdings, Inc. (W2E). In September 2009, W2E, in dire need of financing, commenced a $15 million convertible debenture offering, for which Charles Vista would serve as the exclusive placement agent. While W2E’s most recent SEC filings at that time contained no indication of any possible devaluation of the company’s assets, on October 1, 2009, following an audit, W2E filed an amended Form 8-K, in which it disclosed a significant impairment of its intangible assets. On that same day, W2E filed a quarterly report valuing its total assets for the second quarter of 2009 as only $660,408. Lorenzo was aware of W2E’s filings of October 1, and in fact received an email from W2E’s Chief Financial Officer several days later that explained the reasons for the significant devaluation of the company’s intangible assets. Nevertheless, on October 14, Lorenzo sent emails to two potential investors conveying “several key points” about W2E’s debenture offering. His emails failed to disclose the devaluation, and instead assured both investors that the offering came with “3 layers of protection.”  

In February 2013, the SEC commenced cease-and-desist proceedings against Lorenzo, charging him with violations of three securities law provisions: Section 17(1)(1) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 promulgated thereunder. An administrative law judge concluded that Lorenzo had “willfully violated the antifraud provisions” of the statutes at issue “by his material misrepresentations and omissions concerning W2E in the emails” to the two potential investors. She found that Lorenzo had sent the emails without thinking about their contents, but that doing so amounted to recklessness, satisfying the scienter requirement. Upon review, the SEC sustained the ALJ’s decision, including her “imposition of an industry-wide bar, a cease-and-desist order, and a $15,000 civil penalty.” Specifically, the SEC found that Lorenzo had violated Rule 10b-5(b), which prohibits the making of materially false and misleading statements in connection with the purchase or sale of securities, because he knew that each of the key statements in his emails “was false and/or misleading when he sent them.” Lorenzo petitioned for review by the D.C. Circuit.  

Contrary to the SEC’s conclusions, the D.C. Circuit ruled that Lorenzo did not “make” the statements at issue within the meaning of Rule 10b-5(b), finding that he had simply transmitted statements devised at the direction of his superiors. It nonetheless “conclude[d] that his status as a non-“maker” of the statements at issue does not vitiate the [SEC]’s conclusion that his actions violated the other subsections of Rule 10b-5 as well as Section 17(a)(1).” While Rule 10b-5(b) states that it is unlawful to “make any untrue statement of a material fact … in connection with the purchase or sale of any security,” the other securities law provisions at issue do not contain such more general terms of “employ[ing],” “us[ing],” or “engag[ing]” in deceptive conduct in connection with securities transactions. Accordingly, a majority of the court concluded that “Lorenzo, having taken stock of the emails’ content and having formed the requisite intent to deceive, conveyed materially false information to prospective investors about a pending securities offering.” As such, they found that Lorenzo had engaged in deceptive conduct and had acted with scienter. Accordingly the court upheld the previous findings with respect to his liability.  

In a strongly worded dissent, Judge Kavanaugh vehemently disagreed, blasting the actions of the SEC. First, he concluded that the SEC, similarly to his colleagues in the majority, had failed to “heed the administrative law judge’s factual conclusions” concerning Lorenzo’s “not thinking about” the accuracy of the information his boss had sent him and which he forwarded to the investors. He bitterly criticized the SEC for having “simply manufactured a new assessment of Lorenzo’s credibility and rewrote the [administrative law] judge’s factual findings.” Yet, despite the ALJ’s conclusion that Lorenzo had “not thought about” the accuracy of the emails, she did specifically find that Lorenzo had acted with scienter – presumably because it is, in fact, extremely reckless to send information to investors without thinking about whether it was true or not. Judge Kavanaugh’s dissent makes no mention of that fact.  

Of wider import, however, is the dissent’s savaging of the SEC, while sympathizing with a broker’s actions in conveying to investors information that he knew was false and misleading. In his view, this case was just another example of the SEC’s efforts, over a period of decades, to evade the Supreme Court’s prohibition of liability under the securities laws for “aiders and abettors.” In his view, this case involves “nothing more” than the making of false statements, and since Lorenzo did not himself “make” the false statements he should not be held accountable for them under any theory of liability.

The majority opinion creates a circuit split by holding that mere misstatements, standing alone, may constitute the basis for … willful participation in a scheme to defraud--even if the defendant did not make the misstatements. …Other courts have instead concluded that scheme liability must be based on conduct that goes beyond a defendant’s role in preparing mere misstatements or omissions made by others.  

Judge Kavanaugh thinks that it was incongruous to conclude both that: (i) Lorenzo had not “made” any statements, but merely transmitted the emails at issue; and (ii) “Lorenzo nonetheless willfully engaged in a scheme to defraud solely because of the statements made by his boss.”  The granting of certiorari in this case indicates that the Supreme Court is interested in this issue, and that this is going to be an important case for establishing the contours of scheme liability.

In our view, Judge Kavanaugh got it wrong. He seems to have concluded that whenever a false or misleading statement is made, no one can be liable except the person who made it, and that any other rule would eviscerate the prohibition of aiding and abetting liability. In support of this conclusion he relied on several previous Circuit Court decisions which, he argues, held that a defendant cannot be held liable under a theory of scheme liability where the case involved “nothing more” than false statements. In one of those cases, KV Pharmaceuticals, the complaint alleged, in conclusory fashion, that a corporate securities filing was false and misleading and that two of the company officers knew about it. The court held that, to be liable in such a case, a complaint had to allege that the defendants did something more than merely know that their company had made a false filing. It concluded that “the investors do not allege with specificity (or otherwise) what conduct Van Vliet and Bleser engaged in beyond having knowledge of the misrepresentations and omissions.” The court did not mention aiding and abetting; it merely held that scheme liability must entail actions beyond mere awareness that someone else had made a misstatement.

In another case, Luxembourg Gamma Three, the scheme liability claim was simply another label plaintiffs had applied to a classic non-disclosure case against the same people who had themselves made the false and misleading statements. As the court said, “the fraudulent scheme allegedly involved the Defendant-Appellees planning together to not disclose the Founders’ sale of securities in the secondary offering, and then not disclosing those sales; fundamentally, this is an omission claim.”

In Lorenzo the claims against the defendant went beyond “making” a false or misleading statement. Lorenzo sent the false information, under his own name, to investors, and implicitly vouched for its accuracy. If that is not enough to establish scheme liability, what is?

Judge Kavanaugh’s dissent reflects his hostility towards the SEC itself, confirming the Trump administration’s statement nominating him to SCOTUS. There it specifically touted the fact that he has “overruled federal agency action 75 times.” He is, in fact, widely regarded by commentators on both the left and the right as hostile to the “administrative state.” His dissent in Lorenzo is a prime example of this. First he mocked the agency’s determination that Lorenzo acted with scienter, which he claimed contradicted the findings of the ALJ even though the ALJ held that Lorenzo had acted with scienter. Then he lashed out at the agency for what, in his view, amounted to trying to make an end run around Supreme Court case law that sharply distinguishes between primary and secondary liability. It is hard to avoid the conclusion that, in his view, the SEC is a rogue agency that simply has to be reined in.  

If he is confirmed, it will be another sad day for investors.

SEC Says Bitcoin, Ether are Not Securities


A recent spike in interest surrounding cryptocurrencies has left investors wondering whether or not the federal securities laws apply to transactions involving digital currency such as Bitcoin and Ether. As noted in previous Monitor articles, broadly speaking, cryptocurrency is a form of payment that can be exchanged online, with digital “tokens,” for goods and services. Unlike traditional currency, cryptocurrency exists solely in the digital realm and is not backed by any government or central banking entity. Interest in cryptocurrency reached a fever pitch in 2017, as cryptocurrencies, such as Bitcoin, experienced dramatic increases in value. By way of example, one Bitcoin traded for approximately $1,000 in January 2017 and reached a high of $19,500 in December 2017. In July 2018, the currency dipped below $6,000 per Bitcoin, and the price continues to fluctuate. Given such volatility, speculators have started purchasing cryptocurrencies as investments. In determining whether the federal securities laws apply to these purchases and sales, the salient question is whether purchasers are investing in the currencies themselves or in the network or platform on which they run. The backbone of the cryptocurrency ecosystem is a decentralized technology known as blockchain, which is spread across many computers that manage and record transactions in cryptocurrency. Bitcoin, the original cryptocurrency, was developed as a “peer-to-peer electronic cash system” and allows online Bitcoin payments to be sent directly to a party without the involvement of any financial institution or other third party. Similar, but slightly different, is the Ethereum blockchain, for which Ether is the underlying token. Although Ether is traded on public markets, it was not intended to be a unit of currency on a peer-to-peer payment network; rather, it is a necessary input, often called the “native asset,” used to pay the Ethereum platform, a decentralized world computer upon which users can build and run applications, to perform certain tasks. For this reason, Ether is sometimes characterized as a cryptocommodity rather than a cryptocurrency, but it can and does function like a cryptocurrency in many respects. In terms of market value, Ether and Bitcoin are the two largest cryptocurrencies or tokens currently available to investors. In an effort to clear up confusion, William Hinman, director of the SEC’s division of corporation finance, recently stated that transactions in Bitcoin and Ether are not subject to federal securities laws, calming concerns that the SEC may seek to regulate these transactions. In prepared remarks delivered on June 14, 2018, Hinman noted that, in determining whether a cryptocurrency is a security, a central consideration is how the cryptocurrency is being sold and the “reasonable expectations of purchasers.” For example, where cryptocurrency is being sold chiefly as an investment in an enterprise or cryptocurrency platform, as is the case in some Initial Coin Offerings (“ICO”), the SEC takes the position that the transaction is a securities offering subject to the federal securities laws and should be registered. Conversely, once a sufficiently decentralized network for the exchange of a cryptocurrency has been established, such that it would be difficult to even identify an issuer or promoter to make the requisite disclosures to investors, sales of the cryptocurrencies will not be subject to the federal securities laws. Hinman noted that “the network on which Bitcoin functions is operational and appears to have been decentralized for some time, perhaps from inception.” Hinman added that “putting aside the fundraising that accompanied the creation of Ether, based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions.” Finally, Hinman left the door open to other digital currencies escaping SEC scrutiny, stating that “over time, there may be other sufficiently decentralized networks and systems where regulating the tokens or coins that function on them as securities may not be required.” The price of Bitcoin and Ether both increased on this news. Hinman also laid out a roadmap of sorts for establishing a cryptocurrency exchange and insuring that investors have clear expectations regarding their cryptocurrency transactions. In order to get an exchange off the ground, Himan suggested raising initial funding through a registered or exempt equity or debt offering, rather than an ICO. After the network has already been established and is sufficiently decentralized, tokens or cryptocurrency can then be offered in a manner whereby it is evident that purchasers are not making an investment in the development of the cryptocurrency network, but rather are purchasing an asset used to purchase a good or service. While the current state of play for Bitcoin and Ether appears to be settled, at least from the perspective of the SEC, there is sure to be confusion going forward as additional forms of cryptocurrency proliferate and new exchanges lure additional investment.

Pomerantz Paves Way For Use of Confidential Informants' Allegations


In Cohen v. Kitov Pharmaceuticals Holdings, Ltd., Judge Lorna Schofield of the Southern District of New York sustained, in part, the class action claims of lead plaintiffs represented by Pomerantz and the Rosen Law Firm. We brought these claims under Sections 10(b) and 20(a) of the U.S. Securities Exchange Act of 1934 and Rule 10b- 5, against defendants Kitov Pharmaceuticals Holdings, Ltd. and its CEO Isaac Israel. This was a significant victory for plaintiffs, primarily because Judge Schofield adopted an ideal blend of crediting confidential informants’ allegations about a relatively small corporation, while protecting them from retaliation. Kitov is an Israeli biopharmaceutical company. Its American depository shares trade on the NASDAQ. Kitov’s leading drug candidate is KIT-302, a fixed-dosage combination product based on two generic drugs designed to treat pain and hypertension. To commercialize the drug, it was necessary for the company to obtain FDA approval of KIT-302’s New Drug Application (“NDA”). A milestone in this process would have been reached when pivotal clinical trials were completed, the data was analyzed, and the data analyses demonstrated promising results in reducing blood pressure. To facilitate FDA approval, Kitov agreed to a procedure requiring it to conduct a detailed Phase 3 study (the “Study”). Kitov’s board of directors appointed an independent committee to evaluate whether the Study results were good enough to support the NDA. After reviewing the results, the committee determined that the Study had, indeed, demonstrated the drug’s efficacy. Plaintiffs alleged that the Study results were falsified prior to submission to the committee and that the actual, undisclosed results failed to provide statistically significant evidence of efficacy. Although the company never admitted what had happened, the truth emerged. On February 6, 2017, Mr. Israel was reportedly arrested and questioned by the Israel Securities Authority on suspicion of fraud. The next day, Kitov issued a press release announcing the launching of the formal investigation, while maintaining that it “stands fully behind the validity of all of its clinical trial results” and that it “continues to move forward toward the filing of [its] New Drug Application for KIT-302 with the FDA.” The price of Kitov’s ADS dropped precipitously after these revelations.

IDENTIFYING THE INFORMANTS. Scienter, defined as acting deliberately or recklessly in misrepresenting the facts, is an essential element of any securities-fraud claim. To state a cause of action, plaintiffs must allege facts constituting strong circumstantial evidence of conscious misbehavior or recklessness. This can be shown where a defendant engaged in deliberate illegal behavior, knew facts or had access to information contradicting its public statements, or failed to review or check information that the defendant had a duty to monitor. Judge Schofield held that, to satisfy this requirement, “[a] complaint may rely on information from confidential witnesses if they are described in the complaint with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged.” In support of its claim, the complaint cites information provided by several former Kitov employees and consultants. Significantly, Judge Schofield found that plaintiffs had sufficiently alleged scienter against Kitov and Mr. Israel, based, in part, on relatively general allegations from confidential informants. These allegations were relatively broad because the company, at any given time, never engaged more than ten people as employees or consultants, whose anonymity would have been jeopardized had more specific allegations been provided. Critical to this finding was plaintiffs’ reliance on several former Kitov consultants for allegations that Mr. Israel falsified the Study data: “[A]ccording to several former consultants of Kitov with knowledge of the clinical trial results, Israel was the individual who directed that the . . . data be falsified to show efficacy[.]” Judge Schofield stated that while this description may not have sufficed in an organization with hundreds of employees, any more detailed description here likely would have revealed the identity of the sources. This evidence from multiple former consultants, combined with Mr. Israel’s position as head of a small organization and news of the ISA’s investigation, gave rise to a plausible inference that Mr. Israel was responsible for the falsification of data. Judge Schofield emphasized that “[r]equiring disclosure of confidential sources could deter them from providing information ‘or invite retaliation against them.’”

DUTY TO SPEAK THE FULL TRUTH. Another major issue in the case was whether defendants had a duty to disclose that the results of the Study had been falsified. Defendants argued that they had no duty to provide any details about the Study. The court disagreed, holding that “[O]nce a company speaks on an issue or topic, there is a duty to tell the whole truth, even where there is no existing independent duty to disclose information on the issue or topic.” When defendants made statements about the Study results, including, without limitation, that they “successfully met the primary efficacy endpoint of the trial protocol[,]” they made material omissions by failing to disclose that the results had been falsified. Defendants argued that the failure to disclose falsified data was not actionable because the results were not falsified: they quoted their own SEC filings to argue that the Study was conducted by independent research organizations and that defendants had no access to the data and therefore could not have tampered with the results. But Judge Schofield, crediting plaintiffs’ allegations, found this argument unpersuasive because it was premature on a motion to dismiss.

LOSS CAUSATION. Finally, defendants argued that the complaint did not properly allege “loss causation”—that the misrepresentations concerning the Study did not “cause” the price of Kitov stock to drop. Typically, loss causation is established by showing that a curative disclosure of the true facts occurred, followed directly by a drop in the price of the company’s stock. Here, defendants argued that because they never admitted that the results of the Study were falsified, there was no curative disclosure and, therefore, no loss causation. They also argued that the results of the Israeli investigation into the company had not been disclosed when the stock price fell and therefore could not have caused the losses, asserting that plaintiffs must have shown that a “misstatement or omission concealed something from the market that, when disclosed, negatively affected the value of the security.” Judge Schofield found that disclosure of the investigation and the subsequent drops in Kitov’s ADS prices sufficiently demonstrated loss causation, even though Kitov released a statement that it stood by its earlier disclosures about KIT-302 and was on track with its NDA approval.

The Supremes Rule on Tolling the Statute of Limitations

Attorney: Aatif Iqbal
Pomerantz Monitor July/August 2018

Class actions are brought by individuals or institutions (the proposed (“named”) class representatives) who seek to represent a “class” composed of a large number of parties (the “absent class members”) who, they believe, have been similarly victimized by the same wrongdoing. Can absent class members rely on the class action to protect their rights, or should they bring their own lawsuits? It may take years for the court to decide whether the action should be dismissed or properly proceed as a class action. What happens if, before the court makes such a determination, the statute of limitations expires? If the court then refuses to certify the class, or dismisses the action altogether, is it too late for individual class members to act to protect themselves? Until recently, the answer was an unequivocal “no.” A recent decision by the Supreme Court in China Agritech, Inc. v. Resh now makes the answer unsure. Decades ago, in American Pipe & Construction Co. v. Utah, and then in Crown, Cork & Seal Co. Inc. v. Parker, the Supreme Court held that a timely-filed class action tolls the statute of limitations for all would-be class members—so that, if the class action is dismissed or class certification is denied after the limitations period has run out, they can still pursue their individual claims by filing a new lawsuit. The Court reasoned that one of the main purposes of the class action device is to make it unnecessary for similarly situated plaintiffs to rush to pursue their claims individually, resulting in courts being inundated with countless duplicative individual actions, all raising essentially the same issues. This benefit would be eroded if statutes of limitation forced class members “to file protective motions to intervene or to join in the event that a class was later found unsuitable.” American Pipe addressed this problem by protecting class members’ rights to pursue other options if the class action failed. This made it possible for class members to rely on a pending class action to protect their interests, while holding off on pursuing other options until after a court could decide if class treatment was appropriate. At that point, they could make a more informed decision about what to do. In fact, the Court emphasized that absent class members had no “duty to take note of the suit or to exercise any responsibility with respect to it” until after “the existence and limits of the class have been established and notice of membership has been sent.” In other words, the best way for class members to promote the “efficiency and economy of litigation” was to wait for a court to rule on class certification before pursuing other litigation options. But more recent court decisions have sharply limited the scope of American Pipe tolling, eliminating many of its efficiency benefits and forcing absent class members to make premature protective litigation decisions. Last year, in California Public Employees’ Retirement System v. ANZ Securities Inc., the Supreme Court held that although a timely class action tolls the statute of limitations, it does not toll statutes of repose. Statutes of repose begin as soon as a defendant’s violation takes place, whereas statutes of limitation don’t start to run until a plaintiff discovers or should have discovered the defendant’s violation. (For example, the Securities Act has a 1-year statute of limitations and a 3-year statute of repose; and the Exchange Act has a 2-year statute of limitations and a 5-year statute of repose.) So class members cannot wait until they receive a notice about class certification being granted or denied before deciding whether to opt out or pursue an individual claim, as the American Pipe Court instructed. If a class certification ruling takes more than 3 or 5 years— as is increasingly common—then class members have forfeited their right to opt out or file any individual action. This creates perverse incentives for defendants to delay class certification so as to cut off potential class members’ opt-out rights. Now, in China Agritech, Inc., the Supreme Court has limited the scope of American Pipe once again, holding that, even within the repose period, if class certification is denied after the limitations period has passed, former class members can file new individual actions, but they cannot file a new class action, even if class certification had been denied, solely because the previous class representative was inadequate. The Supreme Court unanimously held that the pendency of an existing class action does not toll the statute of limitations for claims brought on behalf of a class. As a result of the Supreme Court’s ruling, if the statute of limitations expires and the original class action is later dismissed, or class certification is later denied, it is too late for class members to file another class action. Now, those who fear that class certification may be denied after the statute of limitations expires can no longer afford to wait to see how the class action unfolds. They must file their own separate class action suit right away. It is therefore increasingly important to monitor class actions closely from the outset, in order to make informed decisions early on about whether to stay in the class, fight for class leadership, or file a separate class action. The Court reasoned that American Pipe tolling promoted efficiency for individual claims because there was no reason for plaintiffs to bring individual claims until after class certification had been litigated. But any competing class representative claims were most efficiently addressed early on and all at the same time, so that courts could hear all the parties’ relevant arguments, select the best class representative, and then either grant or deny class certification once and for all. The Court also reasoned that any would-be class representative who filed a lawsuit after the limitations period could “hardly qualify as diligent in asserting claims and pursuing relief,” as is ordinarily required both to benefit from equitable tolling and to show adequacy as a class representative. Finally, the Court reasoned that limiting American Pipe tolling in this way was necessary to prevent a “limitless” series of successive class actions, each rendered timely by the tolling effect of the previous ones. However, as Justice Sotomayor pointed out, this reasoning may have been viable with respect to securities class actions such as China Agritech itself, but far less so in in other kinds of class actions that may raise more difficult questions about how to structure a class or subclasses. Among other things, the Private Securities Litigation Reform Act already mandates an early process for resolving competing class representative claims following the dissemination of notice. But in employment or consumer class actions, it may be far more efficient to encourage absent class members to wait and see if a proposed nationwide class is viable before forcing them to file precautionary class action lawsuits with regional or other kinds of subclass structures. But under China Agritech, class members who take this “wait and see” approach would be deemed not “diligent” enough. Even worse, what if a case turns out to be perfectly suited for class treatment, but class certification is denied solely because the class representative is inadequate? Then the former class members would be able to pursue their claims through duplicative individual actions, all raising essentially the same issues, but not through a class action – even though they can satisfy every element of Rule 23. The result is that, in many class actions, the availability of effective avenues for relief will turn largely on accidents of timing, forcing absent class members to make premature decisions to protect themselves, and thus squandering many of the efficiency and consistency benefits of the class action device.      

Court Denies Motion To Dismiss Our Quorum Health Corporation Complaint

Attorney: Michael J. Wernke
Pomerantz Monitor May/June 2018

Chief Judge Waverly D. Crenshaw, Jr. of the Middle District of Tennessee recently denied defendants’ motion to dismiss Pomerantz’s securities fraud class action involving Quorum Health Corporation (“Quorum”) and Community Health Systems, Inc. (“CHS”). CHS is one of the nation’s largest operators of hospitals. Quorum, an operator and manager of hospitals, was spun off from CHS in April 2016. The action, brought on behalf of investors in Quorum who purchased Quorum shares after the spinoff, alleges that Quorum, CHS and certain of their officers violated section 10(b) of the Securities Exchange Act as well as section 20(a), the “control person” provision, by issuing financial statements for Quorum that misrepresented its financial condition.

Specifically, our complaint alleges that CHS hatched a scheme to unload its worst-performing hospitals at an inflated price. It set up the new subsidiary, Quorum, to buy these hospitals from CHS for $1.2 billion, which Quorum borrowed. That price was based on fraudulent calculations of “good will” attributable to those hospitals. Goodwill is an intangible asset that that results when one company purchases another for a premium value. The value of a company’s brand name, cus­tomer base, and good customer relations are examples of goodwill. That is, when a company like CHS purchases hospitals like those that came to make up Quorum, it must record as goodwill the amount it paid for those hospitals in excess of the fair value of the assets. A company must then periodically test the goodwill and record an “impairment” to the goodwill when it is more likely than not that the fair value of the as­set has declined below its carrying amount (or book value). This occurs when “triggering events” lead management to believe that the expected future cash flows of an asset have significantly declined.

The inflated value of Quorum’s goodwill was then reflected in Quorum’s financial statements, which were dissemi­nated to investors when Quorum’s stock started trading as a separate public company.

We allege that the defendants knowingly inflated Quorum’s goodwill and failed to take a necessary impairment. As a result of the defendants’ false statements about Quorum’s goodwill, investors that purchased Quorum stock in the market following the spin-off paid an inflated price. The truth was revealed when Quorum and CHS each announced only a few months after the spin-off was completed (and CHS received its $1.2 billion) that each company was severely impairing its goodwill. As a result, Quorum’s stock price plummeted $4.99, almost 50%, damaging investors.

Defendants’ main argument for dismissal was that their statements of goodwill, which are considered statements of opinion under the law, were not false and misleading when made, or made with the intent to mislead inves­tors. The court rejected these arguments, finding that the multiple “triggering events” or “red flags” indicating that the goodwill was impaired were known to the defendants prior to the spin-off. For example, in the months prior to the spin-off, CHS’s stock price decline 78%, correspond­ing to a decline in market capitalization of $5.6 billion. The court also noted the extremely poor performance of the hospitals that made up Quorum as an indicator that the goodwill was impaired. Thus, the court held that because the complaint alleged that the defendants’ state­ments of goodwill did not fairly align with the information they knew, Pomerantz adequately alleged that the defen­dants knew that their statements of goodwill were false.

This opinion is particularly significant because the court held that the CHS defendants, in addition to the Quorum defendants, were “makers” of the false statements of goodwill in Quorum’s initial financial statements even though the filings were made on behalf of Quorum, not CHS. Normally, only the company and officers whose stock the class purchased are liable for false statements under the federal securities laws. Here, that would be Quorum and its officers. However, the court accepted our argument that CHS and its officers should also be liable for the false statements because Quorum was part of CHS prior to the spin-off and all of Quorum’s financials in the spin-off documents were calculated by CHS.

The Ascendancy Of “Event-Driven” Securities Cases

Attorney: Matthew C. Moehlman
Pomerantz Monitor May/June 2018

Corporate fraud comes to light by different routes. The Securities Exchange Act’s reporting requirements are designed to compel disclosure and transparency by public companies. Even so, investors cannot always count on bad corporate actors to blow the whistle on themselves.

When a third party reports an event that calls in to question the truth of a company’s statements to the market, some commentators refer to the resulting litigation as “event-driven.” These types of cases have become more common in recent years, as companies have found ways to avoid obvious admissions that their previ­ous statements were wrong. In some quarters, particularly the defense bar, event-driven cases are criticized as applying 20/20 hind­sight to an unprecedented bad event. But in our view, this ignores the many cases in which a company knows but conceals a risk that just such an event will occur. When the event then does occur and investors suffer losses due to the market’s reaction to the materialization of the concealed risk, we believe that the company should be held accountable.


Fifteen years ago, securities fraud often came to light when a company restated its past financial results. For example, if a company had engaged in several large, pre-arranged, round-trip transactions with no economic purpose, in order to inflate its reported revenue and cash flow, it might announce that it was restating its financial results to correct them. If the stock then plunged, share­holders suing to recoup their losses could invoke the restatement as an admission that the company’s earlier financials were materially misstated. Since materiality and falsity are two elements of a securities claim, therestatement would significantly strengthen the share­holders’ case.

Times have changed. Litigation analysts report that in the ten years since the Enron securities litigation wrapped up, the number of reissuance restatements filed by pub­lic companies has steadily declined—from nearly one thousand in 2006 to just over a hundred in 2016. Reg­ulatory reforms aimed at deterring accounting fraud may account for the downturn, or corporations may simply have learned that restatements increase litigation risk and learned not to lead with their chins.

In any event, astute shareholders should stay attuned to multiple non-company sources for revelations that dam­age their investment portfolio. Let’s look then at several examples of recent cases in which news reported by third parties prompted shareholder litigation.


A case prosecuted by this firm, the securities litigation re­lating to the Brazilian state-owned energy giant Petróleo Brasileiro S.A.-Petrobras, shows how investors may first learn of a fraud from external sources and events rather than a company announcement.

Reports of corruption had dogged Petrobras for years. The endgame began in early 2014, when newspapers reported that the Brazilian federal police had arrested a retired Petrobras executive as part of a crackdown on black-market money-laundering.

Petrobras did not mention the incident explicitly in its an­nual report filed the following month, saying only that it was conducting routine internal investigations into certain issues.

Petrobras had still not disclosed the findings of those investigations when, months later, the police released sworn affidavits in which the executive testified to orches­trating a decades-long kickback and bid-rigging scheme along with other top Petrobras executives, over a dozen large construction companies, and many of Brazil’s lead­ing political figures.

In addition to not divulging the scheme, Petrobras never restated its financials, despite having overvalued its fixed assets by, according to its own estimates, $30 billion.

Petro­bras wrote off $2.5 billion as kickback-related overpay­ments, and took a $16 billion asset impairment. Petro­bras argued in its motion to dismiss that $2.5 billion was immaterial to its financial results under SEC guid­ance regarding materiality from a legal and accounting standpoint. In denying Petrobras’ motion, the district court observed that materiality is not limited to a purely quantitative assessment but can also include qualitative factors, such as concealment of an unlawful transaction. In that regard, the court noted that Petrobras’ misstat­ed financials concealed an illegal kickback scheme that, when revealed, called into question the integrity of the company as a whole. The court also found that Petro­bras’ assertions of integrity and high ethical standards were actionable because they were alleged to have been made to reassure the market, and the market may have relied on their truth.


Some events that lead to actionable claims implicate a company’s representations about its products. Matrixx Initiatives, Inc. v. Siracusano involved a drug manufac­turer that failed to disclose that its popular cold remedy had caused a small number of users to lose their sense of smell. When a morning television show revealed this potential side effect, the stock plummeted. On appeal to the Supreme Court of the United States, Matrixx argued that the possibility of loss of smell was so minute as to be immaterial. The Court disagreed. It found that misstate­ments need not be statistically significant to be material, and held that Matrixx’s press releases touting the safety and efficacy of the cold drug were actionable.


An event may also reveal a company’s statements about its operations to have been materially false and mislead­ing. In November 2015, it was reported that the Fundão dam in Minas Gerais, Brazil had collapsed, releasing tons of toxic sludge on the village below and leading to the worst environmental disaster in Brazil’s history. The dam was jointly owned by Vale S.A., a multi-national mining concern whose securities trade on NASDAQ.

The dam collapse shattered Vale’s carefully-crafted im­age as a good corporate citizen. While some economists say that the only social responsibility of business is to in­crease profits, socially responsible investing has become a major force across global markets, with over $23 trillion in responsibly invested assets reported to be under man­agement. Vale, like a number of large industrial compa­nies, published a detailed annual “Sustainability Report” in order to win inclusion in the Dow Jones Sustainability Index. Vale stated in one sustainability report that it would “prevent, control or compensate for [environmental] im­pacts,” and that it had “policies, systematic requirements and procedures designed to prevent and minimize risks and protect lives.” The district court found that these statements were actionable. The court, moreover, found that Vale’s executives had been privy to studies showing that the dam was structurally unsound for years before the foreseeable risk of its collapse became a reality.


Pomerantz Secures Milestone Settlement In Yahoo

Attorney: Hui Chang
Pomerantz Monitor May/June 2018

Pomerantz is co-lead counsel in a securities fraud class action suit brought by investors in the Northern District of California on behalf of shareholders of Yahoo! Inc. (“Yahoo”). The case arises from the two biggest data breaches in U.S. history, in which Russian hackers stole the records of all of Yahoo’s three billion users in 2013 and compromised the accounts of 500 million users in 2014. In early March 2018, Yahoo agreed to pay $80 million to settle the action filed by the plaintiff shareholders in the action. Plaintiffs alleged that Yahoo and some its officers failed to disclose that these breaches had oc­curred and also failed to disclose two additional massive data breaches in 2015 and 2016, which affected approxi­mately 32 million Yahoo users and caused financial harm to its investors. The suit further alleged that defendants knowingly concealed its deficient security practices and the 2014 data breach from the market. Plaintiff share­holders alleged that the company’s share price fell over 31 percent during the class period in reaction to its data-breach disclosures. These data breach disclosures also had a substantial and quantifiable financial impact on Yahoo when Verizon Communications, Inc. reduced its bid to acquire Yahoo by $350 million, to $4.4 billion.

The proposed Yahoo settlement, which is still subject to final court approval, will be the first substantial shareholder recovery in a securities fraud class action related to a cybersecurity breach. Historically, data-breach disclosures by publicly traded companies have not been generally followed by significant stock price declines, making it hard to show that investors suffered material harm. With stock prices largely unaffected, cyber-related disclosures have instead mainly driven shareholder derivative orconsumer protection actions. For years, data breach classactions have been typically dismissed early on by courts, and were generally unsuccessful.

Recently, however, investors are far more focused on cybersecurity issues and more highly-publicized data breaches have been accompanied by stock price declines. While in the past, investors seemed to be indifferent to news of data breaches, investors now appear more aware of the increased risks of security breaches. This past year alone saw the filing of a handful of securities fraud class actions related to cybersecurity breaches, with the publicly traded companies Equifax Inc., PayPal Holdings, Inc. and Intel Corporation among those sued following cybersecurity breach announcements.

The Yahoo action is significant for another reason as well: on April 24, 2018, the U.S. Securities and Exchange Commission (“SEC”) imposed a $35 million fine on Yahoo in connection with the 2014 data breach, marking the first time a publicly traded company has been fined for a cybersecurity hack. The SEC recounted in its order that Yahoo found out in December 2014 about Russian hack­ers breaching the company’s systems to obtain user-names, phone numbers, encrypted passwords and other sensitive information, yet did not disclose the hack until 2016, when it was closing a deal with Verizon. While the SEC acknowledges that large companies are at risk of persistent cyber-related breaches by hackers, it did not excuse companies from reasonably dealing with these risks and of responding to known cyber-breaches. The SEC said that Yahoo continued to mislead investors with generic public disclosures about the risks of cyber-related breaches when it knew a significant breach had occurred.

The SEC has also recently toughened its reporting guidelines by updating its guidance on cybersecuritydisclosures. The guidance stresses the importance ofcybersecurity policies and procedures and advisescompanies that they need “disclosure controls andprocedures that provide an appropriate method ofdiscerning the impact that such matters may have on the company and its business, financial condition andresults of operations.” It also calls for public companies to be more open when disclosing cybersecurity risks, with companies expected “to disclose cybersecurity risks and incidents that are material to investors, including the con­comitant financial, legal or reputational consequence.”

This milestone settlement in Yahoo, in combination with updated SEC guidelines, may provide the foundation that allows plaintiff shareholders to bring securities fraud actions to pursue these claims with greater success.As exemplified by the Yahoo action, Pomerantz has been at the forefront of cyber-related securities fraud actions.

Are Cryptocurrency Offerings Subject To Federal Securities Regulation?

Attorney: Michele S. Carino
Pomerantz Monitor May/June 2018

The ability to raise capital through an Initial Coin Offering, or “ICO,” has been hailed as a boon to innovation and economic growth, allowing small businesses and start-ups to bypass traditional (and more expensive) financing sources, such as venture capitalists and investment banks. In fact, in the first four months of 2018, ICOs have raised over $4 billion in funding, already exceeding the $3.3 billion raised in ICOs in 2017, and well ahead of the amounts raised through traditional venture capital.

But what exactly is an ICO, and what are investors buying? And what happens if they don’t get what they expected? Until recently, this emerging, decentralized capital mar­ket has been largely unregulated, exposing investors to price volatility, pump-and-dump schemes, and outright theft by fraudsters and hackers – oftentimes, with no legal recourse. Regulators have now started to take action, making it clear that while cryptocurrencies may be novel, they are not outside the bounds of existing laws.

Cryptocurrency, also known as virtual currency, coins, or “tokens,” is a representation of value that can be digitally traded and exchanged, and that may entitle the owner to certain other rights, such as access to a technology or platform. But it is more than just digital money. Accord­ing to the Securities and Exchange Commission (“SEC”), coins and tokens may also qualify as “securities” under U.S. laws, and thus be subject to regulation, including registration and disclosure requirements. The seminal Supreme Court case SEC v. Howey Co., decided in 1946, sets forth the test for determining if a financial instrument – actual or virtual – is an “investment contract” that meets the definition of a security. Specifically, a transaction is an investment contract if: (1) money is invested in a common enterprise, (2) the investor expects profits from the investment, and (3) the profit comes from the efforts of someone other than the investor. An instrument must meet all three criteria to be considered a security. Coins and tokens, like any other financial instrument, can take many forms, but to the extent a company utilizes coins or tokens to raise capital with the promise of increased value based on the company’s plans or growth prospects (e.g., launch of a new technology or product), coins and tokens seem to satisfy the “common enterprise” and “efforts of others” elements of the Howey test, in the same way as shares of stock. Indeed, just as with stock, the value of a  coin or token on an exchange will fluctuate depending on the perceived performance of the issuing company.

Seeking to avoid the complications and costs of compli­ance with U.S. securities laws, many entities have re-packaged and re-labeled coins as “utility tokens” and have downplayed the expectation of profit and/or prom­ised some future use, such as participation in a digital community. But the SEC recently clarified that labels do not matter: “Whether a par­ticular investment transaction involves the offer or sale of a security – regardless of the terminology or technology used – will depend on the facts and circumstances, including the economic realities of the transaction.” SEC Chairman Jay Clayton further stated: “By and large, the [ICOs] that I have seen … directly implicate the securities registration requirements and other investor protection provisions of our federal securities laws.”

While some have decried the regulatory intrusion into this new digital frontier, and others simply have gone the route of blocking U.S. investors from participating in offerings, the benefits of increased investigation and enforcement more than outweigh the potential downside. Industry insiders, including Joseph Lubin, the co-founder of the cryptocurrency Ethereum, and Brad Garlinghouse, CEO of Ripple, agree that curbing fraud will strengthen and legitimize cryptocurrencies and the distributed ledger platforms (“blockchains”) on which they trade. Moreover, to the extent ICOs mirror initial public offerings or other smaller offerings or private placements, there is already a well-established legal framework to ensure both access to capital and protection for investors, including that the coins or tokens be registered and that the issuer make adequate disclosures. These requirements would provide investors with recourse under the Securities Act for initial sales, as well as potential recovery in the instance of market manip­ulation and insider trading, which have been rampant in secondary markets for coins and tokens.

The SEC’s involvement in this area is likely to increase, as evidenced by the creation of a new cyber task force charged with policing ICOs. That task force already has been busy – the SEC filed a fraud suit against the organizers of the PlexCoin ICO in December, with the founder sentenced to jail by Canadian authorities. In recent weeks, the SEC has launched an investigation into Overstock.com’s token sale through its subsidiary tZero, which was supposed to be the first fully-compliant ICO by a publicly-traded company, but which has now been postponed. The SEC also halted trading in Longfin Corp., a cryptocurrency business, alleging that executives com­mitted securities fraud by running up the stock price and then illegally selling large blocks of restricted stock to the public while the price was elevated. The SEC obtained a court order freezing more than $27 million in trading proceeds before the illicit gains could be transferred to offshore entities.

Cryptocurrencies may still disrupt the financial industry and change the way we do business in the future. How­ever, in terms of regulation, the old adage that “the more things change, the more they stay the same,” may still hold true, especially in terms of investor protection.

Ninth Circuit Resolves Loss Causation Issue Under Section 10(B)

Attorney: Austin P. Van
Pomerantz Monitor March/April 2018

In Mineworkers’ Pension Scheme v. First Solar, Inc., the Ninth Circuit recently resolved an internal conflict in its case law regarding the loss causation requirement of Sec­tion 10(b) of the Exchange Act. The court held that a plain­tiff may prove loss causation by showing that revelation of the very facts misrepresented or omitted by the defendant caused the plaintiff’s economic loss, even if the fraud itself was not revealed to the market. That is, to satisfy the loss causation requirement, a plaintiff need not point to a revelation that the defendants committed fraud, but rather only to a revelation of the facts concealed by the fraud. This commonsense ruling greatly improves the ability of investors in California and elsewhere in the Ninth Circuit to recover losses that were sustained as a result of fraud before the fraud itself was revealed to the public.

Defendant First Solar, Inc. is a large producer of solar panel modules. Plaintiffs, a putative class of purchasers of First Solar’s stock, alleged that the company discov­ered manufacturing defects in its solar panel modules that caused them to lose power within the first several months of use, as well as design defects in the modules that caused them to lose power faster in hot climates. Plaintiffs alleged that First Solar hid these defects and their cost and scope from the market and misrepresented key data in their financial statements.

First Solar’s stock price declined steeply after these defects and their cost and scope were revealed to the market. First Solar initially disclosed the manufacturing defect and significant additional costs related to curing the defect and, over the next year, the company disclosed consistently disappointing earnings and financial results, additional expenses related to curing the product defects, and the departure of the company’s CEO. However, at no point did the company or any other party reveal that First Solar had known about, and misrepresented or fraudulently concealed, any of these problems in the past.

On their motion for summary judgment, defendants ar­gued that plaintiffs had not satisfied the loss causation requirement of Section 10(b) because plaintiffs’ losses were not caused by the revelation that First Solar had committed fraud. Plaintiffs replied that revelation of the facts allegedly misrepresented and concealed by defendants, namely, the company’s product defects and related financial burdens, was sufficient to satisfy the loss causation requirement.

The district court identified two irreconcilable lines of Ninth Circuit case law on this issue. The first line of cases began with In re Daou Sys., where the Ninth Circuit reversed a district court’s decision dismissing a Section 10(b) action on the ground that the plaintiffs had not alleged any disclosures that defendants were engaging in improper accounting practices. The Ninth Circuit held that where disclosure of “the company’s true financial condition” caused the stock to drop, loss causation was satisfied, even though the company’s fraudulent accounting practices were not revealed to the market. The Ninth Circuit took a similar approach in Berson v. Applied Signal Technology, Inc., and ultimately fashioned a standard for loss causation in Nuveen v. City of Alameda when it held that a plaintiff can establish loss causation “by showing that the defendant misrepresented or omitted the very facts that were a substantial factor in causing the plaintiff’s economic loss.”

However, the district court in First Solar recognized that a second line of Ninth Circuit cases had applied a dif­ferent standard. In Metzler v. Corinthian Colleges, Inc., the plaintiff alleged that the defendant, an operator of vocational colleges, had manipulated student enrollment data, and that plaintiff suffered losses when the company issued a press release showing lower earnings than the false data had suggested. The Ninth Circuit affirmed dismissal of the complaint on the ground that plaintiff had failed to allege that the market “learned of and reacted to [the] fraud,” as opposed to merely reacting to reports of the defendant’s newly disclosed poor financial health. In In re Oracle Corp., the Ninth Circuit similarly held that plaintiffs cannot prove loss causation “by showing that the market reacted to the purported ‘impact’ of the alleged fraud . . . rather than to the fraudulent acts themselves.” The Ninth Circuit followed the holdings of Metzler and In re Oracle in Loos v. Immersion Corp. and Oregon Public Employees Retirement Fund v. Apollo Group, Inc., both of which held that loss causation requires a showing that the market reacted to the revelation of fraud, rather than the revelation of the facts concealed by the fraud or the impact of the fraud.

The district court in First Solar ultimately applied the stan­dard from the Daou line of cases and held that plaintiffs did not need to show that the market reacted to the fact that First Solar had committed fraud in order to satisfy the loss causation requirement. However, faced with two irreconcilable lines of cases, the district court requested that the Ninth Circuit resolve the conflict on interlocutory appeal.

In a brief yet unequivocal per curiam opinion, the Ninth Circuit affirmed the district court’s holding, and so upheld its prior rulings in Daou, Berson and Nuveen. The Court announced that “[t]o prove loss causation, plaintiffs need only show a causal connection between the fraud and the loss by tracing the loss back to the very facts about which the defendant lied.” Accordingly, plaintiffs may satisfy the loss causation requirement “even where the alleged fraud is not necessarily revealed prior to the economic loss.”

The Ninth Circuit’s holding in First Solar marks its first definitive resolution of the internal conflict in its case law on loss causation. While the Court did not expressly overrule the Metzler line of cases, it limited those cas­es to their facts. Moreover, the Court made clear that, contrary to Metzler and its progeny, a plaintiff may prove loss causation by showing that defendant’s stock price fell upon revelation of an earnings miss, even if the market was unaware at the time that fraud had concealed the miss.

In recent years, defendants in Section 10(b) actions in the Ninth Circuit have routinely cited to the Metzler line of cases to support an argument that loss causation is absent in any case where losses were sustained prior to the market learning the fact that defendants had committed fraud. This standard from Metzler permitted defendants to escape liability under Section 10(b) if the negative impact of their fraud was revealed to the market prior to revelation of the fraud itself. With First Solar, the Ninth Circuit has closed the door to that argument and, in the process, granted a significant victory for investors seeking to recover for losses due to fraud that occured prior to revelation of the fraud itself.



Dept. Of Treasury Promotes Forced Arbitration For IPO Claims

Attorney: Leigh Handelman Smollar
Pomerantz Monitor March/April 2018

When a company goes public, it seeks to raise money from investors by selling securities through an initial pub­lic offering (“IPO”). To effectuate an IPO, the company must file several documents with the SEC, including a registration statement and a prospectus. In these docu­ments, the company relays its financial statements and other important information about its business, opera­tions and strategy. Investors rely on these documents in determining whether to purchase the company’s securi­ties in the IPO.

Under the securities laws, investors can much more eas­ily recover for misrepresentations in IPO offering docu­ments than misrepresentations in non-IPO public disclo­sures. Section 11 of the Securities Act makes companies automatically liable for any material misstatements or omissions in their registration statements; and all officers and directors who sign the registration statement are also presumptively liable. In order to escape liability, these of­ficers and directors carry the burden of establishing that they did not know, and could not reasonably have known, about the misrepresentations. Investor reliance on these misrepresentations or omissions is also presumed, un­less the company can disprove it.

Of course, most investors cannot practically avail them­ selves of these rights unless they can pursue them in a class action. Except for large institutional investors, which may have large-scale individual damages, most investors’ losses are not great enough to justify bringing an individual securities action. The very threat of class action securities suits helps to keep companies honest, especially in their public filings. Investors are able to seek the full amount of damages from the fraud, whereas a government action typically only seeks disgorgement. Class action securities suits based on false or mislead­ing IPO documents have allowed investors to recover billions of dollars over the years. These investors range from an average citizen holding the security in his/her retirement account, to large pension funds. Private class action securities suits on behalf of investors have been a driving force in holding bad actors accountable. It is well-known that SEC resources are limited and that private enforcement has been more effective in not only holding bad actors accountable, but in deterring wrong­doing as well.

The very effectiveness of these Section 11 remedies has made them a prime target of pro-business groups; and the Trump administration is showing signs that it may well be listening to them, in the guise of promoting more IPOs. The U.S. Dept. of Treasury recently issued a report on ways to reduce the cost of securities litigation, including forced arbitration. Bloomberg News has report­ed that the SEC, under its new chair, Jay Clayton, might be looking for ways to effectively ban securities class actions based on misstatements in IPO documents, in favor of forcing arbitration. Often, class actions are impossible to arbitrate; therefore, requiring arbitration could effectively present an insurmountable barrier to any recovery for all but the minority of investors whose losses are large enough to make an individual action practicable.

While this move may promote more IPOs in the United States, taking away real investor rights has serious implications in the United States securities markets. In general, the SEC has been less successful in recover­ing monies for defrauded investors than private lawsuits. Further, as the Wall Street Journal recently reported, foreign investors purchased over $66 billion in U.S. stocks in 2017, which number is predicted to grow. One of the main reasons foreign investors like to invest in U.S. stocks is that the protections of the U.S. securities laws are stronger than those of other countries. The Petrobras case is a great example. There, investors in a class action who purchased pursuant to U.S. trans-actions were able to recover $3 billion (despite Petrobras bylaws requiring arbitration). However, investors who purchased securities through the Brazilian stock ex­change were required to arbitrate their claims rather than bring a private enforcement action. Those investors recovered nothing.

Aside from individual investors not being able to recover in an arbitration, there is another negative side effect: arbitrations are not matters of public record and, therefore, the deterrent effect is negated. Newly-appointed SEC Commissioner Robert J. Jackson, Jr. has recently stated similar concerns, displaying his skepti­cism for mandatory arbitration of these claims.

While SEC Commissioner Michael S. Piwowar indicat­ed he would be willing to consider such a drastic policy change, SEC Chairman Jay Clayton has told a Senate panel that he is “not anxious” to allow investors to be barred from filing securities class action claims after an IPO. Senator Elizabeth Warren has been vocal about refusing to dilute investor rights in this regard. She told Clayton, “The SEC’s mission is to protect investors, not throw them under the bus.” Further, former SEC Chair­man Harvey Pitt urged Clayton to put this issue on the “back burners,” citing the very limited resources that the SEC is already encountering. Jackson, Jr. also voiced concerns with respect to the limited budget of the SEC. Another critic of the proposed policy change, Rick Flem­ing, Investor Advocate at the SEC, has stated his opinion about mandatory arbitration of shareholder claims this way: “stripping away the right of a shareholder to bring a class action lawsuit seems to me to be draconian, and, with respect to promoting capital formation, counterpro­ductive.”

Chairman Clayton recognizes that the issue is complex, with investor rights pitted against public company rights, each with their own strong advocates. He confirmed that any policy change in this regard would be subject to great debate, reiterating his desire to delay decision on this is­sue: “[This] is not an area that is on my list for where we can do better[.]” In other words, Chairman Clayton does not appear to want to decide this issue anytime soon.

Regulation A+ Earns A D

Attorney: Joshua B. Silverman
Pomerantz Monitor March/April 2018

For more than eight decades, the Securities Act of 1933 has protected investors by requiring full disclosure in initial public offerings. As President Roosevelt explained at the time of its enactment, the statute was intended to restore confidence in public markets by ensuring that important information regarding new issues was not “concealed from the buying public.”

In 2012, the Jumpstart Our Business Startups (JOBS) Act created a new type of offering that largely bypassed these investor protections. Commonly known as a mini- IPO or Regulation A+ offering, the provision allowed small companies to raise $50 million or less with limited regula­tions. Advocates claimed that by bypassing “burdensome” regulations the act would facilitate capital formation, create jobs, and reinvigorate capital markets.

Regulation A+ companies go through only a minimal “qualification” process, avoiding most pre-offering scrutiny from the SEC’s Division of Corporate Finance. Such com­panies are not bound by the “quiet period” rules that restrict advertising of traditional IPOs. As a result, many are promoted by online ads and social media campaigns making aggressive promises. Even worse, Regulation A+ offerings are not subject to the strong private remedy under Section 11 of the Securities Act of 1933.

More than five years after the JOBS Act, none of the promised benefits has materialized. There is no evidence that Regulation A+ has created jobs (except for stock pro­moters) or boosted small business. Peeling back safe-guards, however, definitely hurt investors. Regulation A+ has become a “backdoor” mechanism to facilitate public listings by companies that would not be able to do so by traditional means, and most have resulted in heavy losses. Because most shares in these offerings are foisted on retail investors, they have borne the majority of these losses. But institutions are now getting involved. FAT Brands, for example, claims that institutional inves­tors accounted for 30% of its mini-IPO.

The first company to take advantage of the light-touch regulations, Elio Motors, listed on the OTCQX at $12 after running a heavily-advertised campaign on a crowd­funding site. Shares now languish below $3, less than 25% of their price at the time of listing. Instead of creating jobs, the undercapitalized manufacturer of three-wheeled vehicles has furloughed workers.

More than a dozen other companies have since used Regulation A+ to go public, with many even listing on the NASDAQ or NYSE. A recent study by Barrons magazine confirms that investors lost money in nearly all of these offerings. The fourteen offerings reviewed by Barrons dropped by an average of 40% on a price-weighted basis during their first six months of trading, at a time when the Russell 2000 and S&P SmallCap 600 indexes both registered strong gains.

Predictably, the reduced scrutiny of Regulation A+ has attracted promoters with shady pedigrees. For example, the CEO of Level Brands, Martin Sumichrast, was previously known for bringing low-quality companies public through Stratton Oakmont, the infamous penny-stock brokerage featured in Wolf of Wall Street. Rami El-Batrawi, the CEO and founder of YayYo, a ride-sharing company that filed to go public in 2017, was until recently banned from serving as an officer or director of a public company under a consent judgment settling claims that he manipulated trading of his prior company, Genesis Intermedia.

Although Regulation A+ has been a disaster by any ob-jective measure, lawmakers seem intent to double down. A bill currently pending in the House of Representatives would raise the limit of Regulation A+ offerings to $75 million. Until Congress begins to consider the needs of investors, it truly is “buyer beware.”

Supremes Hold That State Courts Still Have Jurisdiction Over Securities Act Class Actions

Attorney: H. Adam Prussin
Pomerantz Monitor March/April 2018

Since the Securities Act of 1933 (the “Securities Act”) was first enacted, it has provided that state and federal courts have “concurrent” jurisdiction over cases brought under that Act. So Congress passed SLUSA, the Securities Litigation Uniform  Standards Act of 1998, which prevents investors from bringing so-called “covered class actions” under state law which parallel misrepresentation claims under federal securities laws. Generally speaking, section 77p of SLUSA defines “covered class actions” as cases, brought on behalf of fifty or more investors in securities listed on a national exchange, that allege that defendants made misstatements or omissions in connection with initial public offerings, in violation of state law. The intent was to prevent investor plaintiffs from bringing state law cases alleging misrepresentations in securities transactions.

As we reported in the September/October 2017 edition of the Monitor, the Supreme Court had granted certiorari in a case called Cyan. That case poses the question of whether SLUSA deprives state courts of jurisdiction over class actions under the Securities Act.

The Cyan case concerns one of SLUSA’s “conforming” amendments, which added the following phrase to the Securities Act’s provision allowing state court concurrent jurisdiction over Securities Act claims: “except as provided in section 77p of this title with respect to covered class actions.” Since “covered class actions” are defined as actions raising state law claims, not securities laws claims, this “exception clause” seems to be a non sequitur.

So what does SLUSA’s “exception” clause mean? De­fendants said that it means that class actions under the Securities Act can no longer be prosecuted in state courts. Plaintiffs said that section 77p does not actually say that and applies only when a complaint contains claims under both the Securities Act and state law. The government had a third position, which is that such cases could still be brought in state courts, but that defendants could then have them “removed” (transferred) to federal courts.

The Supreme Court has now spoken. In a unanimous opinion, it agreed with the plaintiffs, holding that Securities Act cases can still be brought in state courts, and can­not be removed to federal courts. According to the Court, section 77p “says nothing, and so does nothing, to deprive state courts of jurisdiction over class actions based on federal law. That means the background rule of §77v(a)— under which a state court may hear the Investors’ 1933 Act suit – continues to govern.”

What, then, does the “exception clause” actually remove from state court jurisdiction? In our article last fall, we noted that “the exemption is codified in the jurisdictional provision of the Securities Act, so it must mean that concurrent jurisdiction does not exist for some claims under the Act. What those claims are is a puzzlement that only the Supreme Court can resolve.” As it turns out, the Court could not figure that out either.

The opinion states that the investors might be right that the “exception” clause applies only when the case involves both state law and Securities Act claims. Or it might be there for some other reason. It concluded that “[i]n the end, the uncertainty surround­ing Congress’s reasons for drafting that clause does not matter. Nor does the pos­sibility that the risk Congress addressed (whether specific or inchoate) did not exist. Because irrespective of those points, we have no sound basis for giving the “except” clause a broader reading than its language can bear.”

In cases involving statutory interpretation the Supreme Court has, in recent years, been relying heavily on the “plain meaning” of statutory language, a doctrine that presupposes that Congress, in passing statutes, means exactly what it says and says exactly what it means. Sometimes, though, Congress uses language that makes no sense. That seems to be what happened here.

Defendants in securities cases often believe that state courts will be more favorably disposed towards investor plaintiffs than the federal courts will be. If that is true, the Supreme Court’s decision in Cyan will preserve this tactical advantage for investors.

Recent Derivative Actions Highlight Directors' Obligation To Monitor And Prevent Employee Misconduct

Attorney: Veronica V. Montenegro
Pomerantz Monitor January/February 2018

A pair of recent noteworthy derivative actions highlight directors’ potential liability for failure to prevent miscon­duct by employees. In In re Wells Fargo & Company Shareholder Derivative Litigation, plaintiffs brought a derivative action alleging that the company’s officers and directors “[f]rom at least January 1, 2011 … knew or consciously disregarded that Wells Fargo employees were illicitly creating millions of deposit accounts and credit card accounts for their customers, without those customers’ knowledge of consent.” In a 189-page com­plaint, filed in the Northern District of California, plaintiffs allege that cross-selling, the sale of new products and services to existing customers, was paramount to Wells Fargo’s financial success. Various Wells Fargo annual reports during the time period explained that the com­pany’s strategy was to increase the cross-sell business model and touted Wells Fargo as the “king of cross sell.” In order to fulfill its cross-selling plan, Wells Fargo implemented what was known as the “Gr-Eight Initiative,” which set a strict quota of eight products per household that bankers had to sell. Plaintiffs allege that the setting of these types of quotas translated into pressure on bankers to open numerous accounts per customer.

Like many companies, Wells Fargo’s articles of association include a so-called “raincoat” provision that protects directors from personal financial liability for breach­es of fiduciary duty that do not involve self-dealing or conscious misconduct amounting to bad faith.Such pro­visions have, in the past, made it extremely difficult to prosecute misconduct claims against directors for failing to prevent misconduct by employees. Yet here the court held that the alleged misconduct, as pleaded in the action, could be sufficient to meet the bad faith threshold.

Specifically, here Wells Fargo’s directors and senior management received numerous “red flag” warnings that the quota system was leading to widespread misconduct. For example, in September 2007, Wells Fargo directors received letters from employees discussing how the Gr-Eight Initiative created high-pressure sales conduct that resulted in unethical and illegal activity. Also, in 2008, Wells Fargo began tracking employee complaints regarding unethical sales practices, and between 2008 and 2013, several lawsuits against the company involved allegations of unauthorized account creation. In 2011, two branch managers emailed Wells Fargo CEO John Stumpf warning him that employees were creating fake accounts to meet the company’s sales quotas, and they were fired in retaliation. A December 2013 Los Angeles Times article reported that, based on a review of internal bank documents and courts records and interviews with almost 30 former and current Wells Fargo employees, they had determined that Wells Fargo employees had engaged in fraudulent account opening tactics fomented by the relentless pressure to sell. In September 2016, Stumpf testified before the Senate Banking Committee that he had discussed the article with the board. On April 3, 2015, a former Wells Fargo banker both mailed and emailed a letter to Stumpf and the board advising them of unethical practices in sales due to continuous management pressure, and during the next several months continued to email Wells Fargo representatives, copying the board and asking for updates. Additionally, in May 2015, a consumer class action challenging the illicit account creation scheme was filed against Wells Fargo. In 2014, the Office of the Comptroller specifically identified the need to assess cross-selling and sales practices as part of its upcoming examination of the company’s governance process, and in 2015 it issued several Supervisory Letters highlighting the lack of an appropriate control or oversight structure given corporate emphasis on product sales and cross-selling. In September 2016, Stumpf testified before the Senate Banking Committee that he learned of the fraud in 2013 and that the board learned of it later in 2013 and 2014. In response to written questions, he confirmed that at least from 2011 forward, the board’s Audit and Examinations Committee received periodic reports of Wells Fargo’s Internal Investigations Group, which investi-gates issues involving team members, as well as information on suspicious activity reporting.

In a decision last year, the court refused to dismiss the complaint, explaining that under the standard for director oversight liability and the standard for breach of the duty of care when the company has adopted an exculpa­tory provision protecting directors from financial liability, plaintiffs “must allege particularized fact that show that a director consciously disregarded an obligation to be reasonably informed about the business and its risks or consciously disregarded the duty to monitor and oversee the business.” In denying defendants’ motion to dismiss, the court held that “the extensive and detailed allegations in the complaint plausibly suggest that a majority of the Director Defendants did precisely that.” The court pointed to the numerous “red flag” allegations in the complaint and ruled that when viewed together, these allegations bolstered the conclusion that the director defendants consciously disregarded their fiduciary duties to the company. Additionally, the court rejected defendants’ ar­guments that the termination of 5,300 employees over a period of five years demonstrated that the company’s oversight systems and controls were working, hold­ing that the allegations, taken as a whole, support an inference that director defendants knew that the unauthorized creation practices were not isolated, but rather a systemic issue that was rampant and that the company’s oversight systems and controls for sales integrity issues were inadequate.

Similar issues were presented in a case involving Twenty- First Century Fox (“Fox News”). It started as a request for inspection of corporate books and records under Section 220 of the Delaware Corporations Code, made when a stockholder of record, the City of Monroe Employ­ees’ Retirement System, submitted a production request. The request came soon after the July 2016 complaint filed by former Fox News reporter, Gretchen Carlson, against the company for sexual harassment and wrong­ful termination. Carlson alleged that Fox News CEO Roger Ailes had harassed and retaliated against her. The company opened a full-fledged investigation which led to Ailes’ ouster as well as allegations against Bill O’Reilly and others. In the summer of 2017, Fox News and the City of Monroe Employees’ Retirement System entered into a mediation agreement and the Stipulation of Settlement of the books and records case, filed concur­rently with a verified derivative complaint in the Delaware Court of Chancery, on November 20, 2017. The complaint, filed against CEO Rupert Murdoch, his two sons, the com­pany’s other directors and the Roger Ailes estate, alleges that Fox News had a systemic, decades-long culture of sexual harassment, racial discrimination and retaliation that led to a hostile work environment. It further alleges that the company did not take steps to address work-place issues such as sexual harassment and racial discrimination and that it failed to implement controls sufficient to prevent the creation and maintenance of a hostile work environment. The revelations not only led to numerous sexual harassment settlements and racial discrimination lawsuits, but to departures of talent and damage to the company’s good will and reputation, as well as significant financial harm.

The complaint pointed to numerous past sexual harass­ment allegations against Roger Ailes and Bill O’Reilly, as well as an EEOC settled charge against a mid-level Fox News Executive, as red flags showing that the company was aware of employee misconduct and was still not prompted to open a formal inquiry. Not only was no inquiry conducted until after Carlson’s lawsuit, but the company and the board failed to implement sufficient oversight over the workplace to prevent massive damage to the company. The complaint also detailed that the company has had to pay over $55 million in settlements over the unaddressed misconduct. The settlement provided for $90 million, as well as the implementation of governance and compliance enhance-ments at the company. In their brief filed in support of their motion for court approval of the settlement, plaintiffs’ counsel stated that a corporate board can­not pretend that such repeated conduct is isolated nor that it does not and will not pose a grave risk to companies and their shareholders.

While the Wells Fargo and Fox News cases have various differences, their shared similarity is worth highlighting: turning a blind eye to employee misconduct by failing to investigate red flags and establish strong monitoring controls runs the risk of companies’ executives being held accountable regardless of their lack of participation. Neither of the cases alleged that the company’s directors or executives engaged in the wrongdoing, but rather, that they breached their fiduciary duties because they knew of or consciously disregarded the alleged misconduct and failed to stop or prevent it.

Cryptocurrency: A New Frontier For Securities Fraud

Attorney: Adam Giffords Kurtz
Pomerantz Monitor January/February 2018

Lately, Bitcoin and other digital currencies have been mak­ing headlines almost every day. For good reason: more and more people use them, while their value fluctuates wildly on an almost daily basis. Some proclaim it as the next giant leap forward in commerce, while others fear that it portends a financial apocalypse.

One conclusion, however, seems indisputable: cryptocur­rency is opening the door to a whole new breed of spec­ulators and their inevitable byproduct, securities fraud. The United States Securities and Exchange Commission (“SEC”) has wakened to this new threat by creating a new fraud unit, while Pomerantz recently became the first law firm to file an action alleging securities fraud involving a cryptocurrency company.

But first, a short primer for those who are not yet fluent in the language of bitcoin, blockchain and initial coin offerings.


What is cryptocurrency?
Cryptocurrency is a digital form of money—a type of digital token that relies on cryptography for chaining to­gether digital signatures of token transfers, peer-to-peer networking and decentralization. Cryptography is the science of coding and decoding messages so as to keep these messages secure. Coding takes place using a key that ideally is known only by the sender and intended recipient of the message.

What is Bitcoin?
Bitcoin, the most well-known form of cryptocurrency, was created in 2008 by an unknown person or group of people under the alias Satoshi Nakamoto, and released in 2009 as open-source software—in other words, soft­ware with source code that anyone with programming knowledge can inspect, modify, and enhance. Transac­tions are made with no middle men, and therefore no banks.

Why Bitcoin?
In February 2009, Nakamoto wrote, “The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a frac­tion in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts.”

So what is a bitcoin, if it does not exist in the three-dimensional sphere of paper money, coins, and gold blocks?
Each bitcoin is created in a process called mining, by which transactions are verified and added to the public ledger, known as the blockchain. Anyone with a suffi­ciently robust computer and impressive tech chops can mine for bitcoin, but it is not a task for the casual surfer. One must compile recent transactions into blocks and try to solve a computationally complex puzzle by a very long process of trial and error. The person who first solves the puzzle gets to place the next block on the blockchain and claim the rewards: the transaction fees associated with the transactions compiled in the block, as well as newly released bitcoin. Nakamoto predetermined a hard limit of 21 million bitcoins to be generated by 2140. As of January 2018, 80% of the 21 million has been mined.

How can I get and use Bitcoins?
If you don’t want to earn your bitcoins through mining, you can also purchase them through exchanges set up for that purpose. You register your details via the exchange, deposit your local currency, and then purchase the bitcoin at the current rate of exchange. Once you’ve pur­chased your bitcoin, it is best, for security reasons, not to leave it on the exchange for too long, but instead to move it into a software wallet, such as the Bitcoin QT client, where it will be stored on your own computer until you are ready to make a purchase or sell your bitcoin. Today, any individual investor can open a bitcoin wallet online and buy a bitcoin with U.S. dollars or other currency, and then buy and sell on any number of online cryptocurrency or ICO trading platforms.

According to a December 2, 2017 article in Business Insider, one of the first tangible items ever purchased with the cryptocurrency was a pizza. Today, the amount of bitcoin used to purchase those pizzas is valued at $100 million. Obviously, you can buy pizzas with bitcoin only if the restaurant accepts it.

In 2017, the value of Bitcoin was up over 1,300%, while other cryptocurrencies, such as Ripple, Litecoin and Ethereum, were up over 36,000%, 5,000% and 9,000%, respectively. There have also been massive declines in value, but so far these have not been permanent. These wild fluctuations provide fertile grounds for speculation, not to mention fraud.

How do crypto tech startups raise money?
In 2017, tech startups, mostly in crypto tech, raised over $4 billion in startup capital through a new crypto tech funding method called Initial Coin Offerings (“ICO”), which is also based on blockchain technology. ICOs are like a cross between a traditional Initial Public Stock Offering and crowdfunding. Instead of buying shares of stock, investors typically acquire “crypto coins,” which the company produces or hopes to produce, and which investors hope will increase in value once the venture is launched. Thus, ICOs differ from traditional IPOs in that purchasers are not getting an ownership stake in a private company and its proprietary software. They are, in effect, buying the venture firm’s currency, which may or may not prove to have value. That is one reason ICOs have become notorious for pump-and-dump scams.

The blockchain.
The blockchain is the technology that makes Bitcoin, cryptocurrencies and ICOs work. In short, the blockchain technology is open-source software that creates a ledger maintained and visible by all users, and that cannot be altered or erased. The blockchain is like an immutable, comprehensive, real-time Google Docs Excel spread­sheet maintained and visible by every user that correctly records every transaction.

In a NYT article dated January 16, 2018, Steven Johnson wrote:

The only blockchain project that has crossed over into mainstream recognition so far is Bitcoin, which is in the middle of a speculative bubble that makes the 1990sinternet I.P.O. frenzy look like a neighborhood garage sale. And herein lies the cognitive dissonance thatconfronts anyone trying to make sense of the blockchain: the potential power of this would-be revolution is being actively undercut by the crowd it is attracting, a veritable goon squad of charlatans, false prophets and mercenaries. … the Bitcoin bubble may ultimately turn out to be a distraction from the true significance of the blockchain.

Nefarious ways bitcoins have been used.
One of the key features of cryptocurrency is the anonymi­ty of transactions. When the Silk Road, an online market­place for illegal drugs, launched in 2011, it used bitcoin as its chief form of currency. According to the same De­cember 2, 2017 article in Business Insider quoted above:

Bitcoin is inherently traceless, a quality that made it the ideal currency for facilitating drug trade on the burgeon­ing internet black market. It was the equivalent of digital cash, a self-governing system of commerce that pre­served the anonymity of its owner.

With Bitcoin, anyone could take to the Silk Road and purchase cannabis seeds, LSD, and cocaine without re­vealing their [sic] identities. And the benefit wasn’t entirely one-sided, either: in some ways, the drug trafficking site legitimized Bitcoin as a means of commerce, even if it was only being used to facilitate illicit trade.

The energy used to mine for bitcoins.
The creation of each virtual bitcoin consumes real en­ergy—an exorbitant amount. According to a December 2017 article in Ars Technica, the bitcoin network is con­suming power at an annual rate of 32TWh—about as much as the country Denmark. Each Bitcoin transaction consumes 250kWh, enough to power a home for nine days. Some crunching the numbers predict that the Bitcoin network will use as much electricity as the entire world does today by early 2020, a sober­ing thought.


Pomerantz and the SEC are actively in­volved in anti-fraud §10(b)(5) efforts and enforcement activity, respectively, as they pertain to the cryptocurrency and ICOmarketplace.

Last year, the SEC made it clear that most ICOs and the sale of their tokens will constitute the sale of securities within the meaning of the U.S. securities laws and, therefore, most ICOs will be subject to SEC registration, enforcement and the securities’ antifraud laws. Since this first enforcement action, SEC Chairman Clayton specifically warned that the SEC will investigate and prose­cute ICOs for securities law violations, and that he had yet to see an ICO that was not a sale of securities required to comply with all securities laws.

The SEC also announced the formation of a new, ro­bust internal cyber-crime unit that will police the crypto marketplace targeting distributed ledger technology and ICOs for securities law violations. In December 2017, the SEC obtained a cease and desist order against a tech company that was in the process of a $15 million ICO, for selling unlicensed securities. Currently, China and South Korea have banned Bitcon trading, and recently

The only blockchain project that has crossed over into mainstream recognition so far is Bitcoin, which is in the middle of a speculative bubble that makes the 1990sinternet I.P.O. frenzy look like a neighborhood garage sale. And herein lies the cognitive dissonance that confronts anyone trying to make sense of the blockchain: the potential power of this would-be revolution is being actively undercut by the crowd it is attracting, a veritable goon squad of charlatans, false prophets and mercenaries. … the Bitcoin bubble may ultimately turn out to be a distraction from the true significance of the blockchain.

Merrill Lynch, the brokerage arm of Bank of America, has banned its financial advisors from trading Bitcoin for their clients because it is “too much of a risk” for investors, according to an internal memo circulated to 17,000 of its of its own traders.

On December 21, 2017, Pomerantz was the first law firm to file a securities fraud class action complaint against the Crypto Company (“CRCW”), a crypto currency company. We allege that CRCW engaged in stock manipulation after its shares surged more than 17,000% in less than 3 months and to have made false and misleading statements relating to the compensation of paid promoters and the insider sale of stock. CRCW traded over-the-counter at $575 per share when trading was suspended by the SEC on December 19, 2017.

Pomerantz, at the leading edge of the litigation area relating to cryptocurrency, is working to protect investors in this cryptic and to date under-regulated field.

Pomerantz Achieves “Stunning” Class Action Settlement In Petrobras

Attorney: Emma Gilmore
Pomerantz Monitor January/February 2018

In a significant victory for investors, Pomerantz, as sole lead counsel for the class, along with lead plaintiff Universities Superannuation Scheme Limited, has achieved a historic $2.95 billion partial settlement with Petróleo Brasileiro S.A.–Petrobras–and its related entity, Petrobras International Finance Company, as well as certain of Petrobras’ former executives and directors, as well as a $50 million settlement with Petrobras’ auditor, Pricewaterhouse Coopers Auditores Independentes. This is not only the largest securities class action settlement in a decade, but is the largest settlement ever in a class action involving a foreign issuer, the fifth-largest class action settlement ever achieved in the United States, and the largest settlement achieved by a foreign lead plaintiff.

The litigation against Brazil’s energy giant, Petrobras, involved accusations that the company concealed a sprawling, decades-long kickback scheme from investors. The scandal ensnared not only Petrobras’ former ex­ecutives but also Brazilian politicians, including former presidents and at least one third of the Brazilian Congress. According to plaintiffs, defendants’ fraudulent scheme involved billions of dollars in kickbacks, and tens of billions of dollars in overstated assets, resulting in significant loss­es to Petrobras investors. Plaintiffs asserted claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Sections 11, 12(a)(2) and 15 of the Securities Act of 1933.

A January 8, 2018 article in Corporate Counsel reported on the historic settlement: “If any general counsel out there are still letting their companies sleepwalk through compli­ance programs, Wednesday’s $2.95 billion class action settlement with the Brazilian oil company Petrobras should smack them wide awake.”

Law360, reporting on the settlement in a January 5, 2018 article, remarked that the “stunning sum combined with a key legal ruling in the case will add gas to the booming market for securities class actions, lawyers say. … At a period when new securities suit filings are nearing all-time highs, such a blockbuster payday will likely encourage other would-be filers.”

The settlement was achieved after nearly three years of hard-fought litigation, including U.S. and foreign discovery and complex motion practice in the Southern District of New York and an appeal at the United States Court of Appeals for the Second Circuit, and during the pendency of a petition by defendants for a writ of certiorari to the United States Supreme Court.

Pomerantz’ achievement is significant not only for the outstanding multi-billion dollar recovery to investors, but also for the precedent-setting decisions achieved during the litigation. Jeremy Lieberman, Co-Managing Partner of Pomerantz, who led the firm’s Petrobras litigation, commented:

We are very pleased with this historic settlement. Throughout the course of this litigation, plaintiffs achieved important precedents at the Second Circuit Court of Appeals regarding the ascertainability requirement during class certification, as well as the utility of event studies for es­tablishing predominance in securities class actions. These precedents will form the bedrock of class action jurisprudence in the Second Circuit for decades to come. Simply put, this litigation and its ultimate resolution have yielded an excellent result for the Class.

Defendants had appealed the district court’s opinion certifying classes of both purchasers of Petrobras equity and debt on multiple grounds, including for failure to satisfy the re­quirement of ascertainability and for failure to satisfy the burden of showing that the Petrobras securities traded on an efficient market. The Second Circuit accepted the appeal and, in an issue of first impression, squarely rejected defendants’ invitation to adopt the heightened ascertainability requirement promulgated by the U.S. Court of Appeals for the Third Circuit, which would have required plaintiffs to demonstrate that determining membership in a class is “administratively feasible.” The Second Circuit also refused to adopt a requirement, urged by defendants, that all securities class action plaintiffs seeking class certification prove through direct evidence (i.e., via an event study) that the prices of the relevant securities moved in a particular direction in response to new information. The Second Circuit rejected the notion that complicated event studies need to be submitted by plaintiffs at the class certification stage, agreeing with plaintiffs that “event studies offer the seductive promise of hard numbers and dispassionate truth, but methodologi­cal constraints limit their utility in the context of single-firm analyses.”

The impact of precedent set by Petrobras was demonstrat­ed when the Second Circuit handed another significant win to plaintiffs in Strougo v. Barclays PLC–another case where Pomerantz serves as sole lead counsel–where, building on its decision in Petrobras, it held that “direct evidence of price impact . . . is not always necessary to establish market efficiency and invoke the Basic pre­sumption” of reliance. Importantly, the Second Circuit also held that defendants seeking to rebut the presumption of reliance must do so by a preponderance of the evidence rather than merely meeting a burden of production.

Pomerantz Partner, Jennifer Pafiti, commented on the rolof the lead plaintiff in Petrobras:

Universities Superannuation Scheme, the largest private pension fund in the United Kingdom, diligently prosecut­ed this case as lead plaintiff to assist in securing a fantas­tic recovery for defrauded investors as well as achieving some key legal rulings along the way. The settlement serves as a reminder to companies, both foreign and domestic, that raise money by issuing stock on a U.S. exchange that, when it comes to corporate misconduct, their investors will be afforded the protection provided by the United States’ robust securities fraud laws.

Jeremy A. Lieberman led the litigation. Key members of the team were Partners, Jennifer Pafiti, Emma Gilmore, and Marc I. Gross; Of Counsel, John A. Kehoe and Brenda Szydlo; and Associate, Justin Solomon Nematzadeh.

Misrepresentations About Company Ethics Policies Should Be Actionable

Attorney: Louis C. Ludwig
Pomerantz Monitor November/December 2017

At the recent Annual Institute for Investor Protection Conference held in Chicago, Professor Ann Olazabal of the University of Miami proposed a heightened emphasis on the enforcement of corporate codes of ethics. While this seems like basic common sense, courts in securities class actions have often seen things quite differently, and have repeatedly characterized statements about company codes of conduct as little more than inactionable PR fluff. Fortunately for investors, a countervailing judicial (and regulatory) trend of accountability has emerged, and may yet imbue corporate codes of ethics with the robust prophylactic function envisioned by Professor Olazabal.

To plead a claim under Section 10(b)(5) of the Securities Exchange Act of 1934, a plaintiff must allege that defendants made a material misrepresentation or omission in connection with the purchase or sale of a security, either intentionally or recklessly. Because so many well-known corporate scandals have been the product of serious ethical lapses, it should be actionable that a company chooses to speak falsely about its adherence to internal ethical standards in investor-targeted communications. Yet courts have proven reluctant to permit cases alleging precisely such facts to move forward.

The Ninth Circuit’s decision in Retail Wholesale & Department Store Union Local 338 Retirement Fund v. Hewlett-Packard Co. and Mark A. Hurd provides a prime example. In that case, following a 2006 ethics scandal in which it was revealed that HP had hired detectives to spy on directors, employees and journalists, the company had revised and strengthened its ethics code, or “Standards of Business Conduct” (“SBC”). In 2010, this purported strengthening was put to the test when it was revealed that Mark Hurd, HP’s then- CEO and Chairman, had sexually harassed an HP contractor and falsified expense reports to hide the relationship. In the press release disclosing Hurd’s resignation, HP admitted that Hurd knowingly violated the SBC and acted unethically. HP’s stock plummeted in response to the announcement of Hurd’s resignation, resulting in a $10 billion loss in market capitalization.

Investors filed suit, alleging misrepresentations in the form of HP’s statements about its ethics, which were inconsistent with Hurd’s conduct, or, alternately, material omissions regarding Hurd’s unethical behavior, which plaintiffs claimed HP had a duty to disclose. The district court dismissed, and the Ninth Circuit affirmed, holding, as an issue of first impression, that HP’s ethics-related representations were neither false nor material, and that the plaintiffs had failed to make out a prima facie claim under the Exchange Act.

First, the Ninth Circuit held that HP and Hurd had made no “objectively verifiable” statements regarding HP’s compliance with the SBC. Instead, the HP court described the SBC statements about it as “inherently aspirational” and therefore not “capable of being objectively false.” The court also concluded that “the aspirational nature of these statements is evident. They emphasize a desire to commit to certain “shared values” outlined in the SBC and provide a “vague statement[ ] of optimism,” not capable of objective verification.” Second, the panel found that HP’s ethical representations were not material because companies are required by the SEC to publish their codes of conduct, and that “it simply cannot be that a reasonable investor’s decision could conceivably have been affected by HP’s compliance with SEC regulations requiring publication of ethics standards.” Third, the court rejected allegations that HP and Hurd misled by omission, reiterating the view that these were “transparently aspirational” statements lacking any ironclad guarantee that nobody at HP would ever violate the SBC. In sum, HP outlines a vision of corporate ethics that is strikingly cynical. Indeed, it might even be asked why the SEC requires that codes of conduct be published if corporations do not believe them, while investors cannot believe them.

While HP drastically limits the circumstances under which a corporate defendant’s noncompliance with its code of ethics gives rise to actionable misrepresentations and omissions under the Exchange Act, there are some silver linings. Around the same time that the HP decision issued, the SEC imposed a $2.4 million fine against United Airlines’ parent company for violating the Exchange Act’s accounting provisions when its CEO failed to follow anti-corruption and anti-bribery procedure. Specifically, the airline had secured approval from the Port Authority of New York and New Jersey to build a maintenance hangar at the Newark Airport in exchange for reopening and operating a previously-closed route for the sole purpose of ferrying the Port Authority chairman to and from his home in South Carolina. The route was referred to internally as the “Chairman’s Flight” in an express nod to the bribery underlying its existence.

The SEC’s action against the company relied in large part on code-of-conduct provisions prohibiting bribery and requiring that any waivers from compliance with the code be both brought before the board of directors and publicly disclosed. There was no record that the relevant permission was obtained or the relevant disclosures made. Based on this misconduct, the United States Department of Justice entered into a nonprosecution agreement with United that mandated the airline’s development of a rigorous anti-bribery and anti-corruption compliance program. And because, as the HP experience proves, rules do not enforce themselves, U nited was also compelled to review the new policies at least annually and update the Justice Department as necessary to address developments in the field, as well as evolving international and industry standards. Perhaps most critically, United was required to designate an executive to be responsible for the oversight and implementation of these codes, policies, and procedures, and to report on them to the board of directors.

While private litigants unquestionably lack the enforcement muscle of the SEC, the United episode underscores that institutional change can emanate from a renewed focus on code-of-ethics compliance. The ironic challenge for securities fraud plaintiffs is how to spur that focus while the answer – deterrence through increased litigation – is in plain sight. To this end, some district courts have allowed claims premised on codes of ethics to move forward. They have done so by treating the content of ethical codes not as “aspirational” but as a representation of the state-of-affairs on the ground.

For example, in In re Petrobras Sec. Litig., in which Pomerantz is lead counsel, the court upheld a complaint alleging misrepresentations based on the defendant company’s claims that it had “established a commission ‘aimed at assuring the highest ethical standards,’ … that it ‘adopts the best corporate governance practices,’ … that it undertook to ‘conduct its business with transparency and integrity’ and .… that it was ‘fully committed to implementing a fair and transparent operation.’” More recently, the court in In re Eletrobras Sec. Litig. held that the company’s “repeated assertions about its strong ethical standards stand in stark contrast” with subsequently- disclosed criminal activities, and that therefore actionable misrepresentations had been alleged. It remains to be seen whether these cases or the more skeptical view on display in HP will dominate the landscape going forward, but it stands to reason that where a company’s public, ethical face is little more than a mask, investors will continue to be deceived about what  lies beneath.

Congress Shreds Another Pro-Consumer Regulation

Attorney: Susan J. Weiswasser
Pomerantz Monitor November/December 2017

As noted in earlier editions of the Monitor, class action “reform” is most often anything but. Witness the Senate’s October 25 passage of a resolution ending the Consumer Financial Protection Bureau’s (CFPB)’s regulation that banned the use of mandatory arbitration clauses in consumer financial agreements. Those clauses not only mandated arbitration but also prevented aggrieved consumers from suing as a class. The House had already voted down the regulation in July, only two weeks after it had been released. On November 2, the President signed the joint resolution, thus killing the regulation for the foreseeable future.  

The CFPB was one of several new agencies established in 2010 as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The overarching purpose of Dodd-Frank was to address weaknesses in the regulation of financial institutions that led to the financial crisis and recession of the late 2000’s. As the Washington Post noted at the time of Dodd-Frank’s passage, the CFPB was established “to protect borrowers against abuses in mortgage, credit card and some other types of lending[,] … give[] the government new power to seize and shut down large, troubled financial companies[,] … and set[] up a council of federal regulators to watch for threats to the financial system.”

As part of its mandate, the CFPB was tasked with studying the effect of mandatory arbitration provisions in consumer financial contracts. (Dodd-Frank expressly proscribes the use of arbitration clauses in mortgage contracts.) The results, released in early 2015 after a multi-year study, confirmed what many consumers and creditors already knew: customers hardly ever pursue individual legal actions or arbitration against financial service providers. Ultimately, therefore, clauses barring participation in class actions choke off all avenues of relief that wronged consumers might have otherwise received.

The main reason for this failure to litigate or arbitrate on an individual basis is that, unless their losses are large, the investment of time and money required to pursue an individual action is simply not worth it. Moreover, arbitration clauses commonly require the losing party to pay the legal fees of the winning party. This risk is even greater where creditors employ lawyers with high rates who can staff a case with several attorneys.

Since attorneys’ fees in class actions are awarded only if there is a recovery, and are spread out among the entire class, this is the only economically feasible way to pursue all but the largest consumer claims.

Another important advantage to class actions is that the relief granted may include changes to the offender’s business practices, known as equitable relief. Some examples of these changes are writing protections against self-interested transactions-in-lending into a bank’s policies, and incorporating heightened disclosure requirements by credit card companies into consumer contracts. In the long run, these changes can be of greater value than cash payments as they protect consumers into the future and serve as deterrents for potential bad conduct.

So it was particularly troubling when Congress, claiming concern for consumers and economic growth, used an obscure rule to abolish the CFPB regulation. Under the Congressional Review Act (“CWA”), legislators can disapprove regulatory rules of federal agencies before they take effect if done within sixty “legislative” days after the regulation’s release. And this is what Congress did, in an action that typifies its tactics since January. Unable to pass their own laws, legislators have taken to canceling existing regulations even when members have previously supported deference to an agency’s decisions. Since the 2017 inauguration, Congress has effectively invoked the CWA at least 14 times. Previously, the Act had been used successfully only once since its passage in 1996.

According to a recent Washington Post article, members of Congress  who voted for the CFPB rule’s abolition maintained that keeping  it “would trigger a flood of frivolous lawsuits and drive up credit card rates. Arbitration, they argued, was a faster, cheaper way to settle disputes.” That argument presupposes that all or most consumer class actions are “frivolous.” That is a self-serving assumption promulgated by the potential targets of such litigation, such as big banks. Those lawsuits  that are truly frivolous usually do not get very far, and the possibility that some class actions might not have much merit hardly justifies eliminating them altogether – which is the practical effect of these mandatory arbitration clauses.

Moreover, class actions provide significantly greater monetary relief than individual court cases or arbitrations. The CFPB’s study noted that “between 2010 and 2012, across six different consumer finance markets, 1,847 arbitration disputes were filed. More than 20 percent of these cases may have been filed by companies, rather than consumers.

In the 1,060 cases that were filed in 2010 and 2011, arbitrators awarded consumers a combined total of less than $175,000 in damages and less than $190,000 in debt forbearance. Arbitrators also ordered consumers to pay $2.8 million to companies, predominantly for debts that were disputed.”

At the same time, “[a]cross substantially all consumer finance markets, at least 160 million class members were eligible for relief over [a] five-year period studied. The settlements totaled $2.7 billion in cash, in-kind relief, and attorney’s fees and expenses – with roughly 18 percent of that going to expenses and attorneys’ fees. Further, these figures do not include the potential value to consumers of class action settlements requiring companies to change their behavior. Based on available data, the Bureau estimates that the cash payments to class members alone were at least $1.1 billion and cover at least 34 million consumers.”

As the director of the CFPB said in an August 22, 2017, NY Times op-ed piece, “In truth, by blocking group lawsuits, mandatory arbitration clauses eliminate a powerful means to get justice when a little harm happens to a lot of people.” In the current climate of deregulation, there will be more and more little harms that will go unremedied.



Second Circuit Upholds $806 Million Judgment After Trial Under The Securities Act

Attorney: Michael Grunfeld
Pomerantz Monitor November/December 2017

In Federal Housing Finance Agency v. Nomura Holding America, Inc., the Second Circuit recently upheld the $806 million judgment handed down by the district court after a bench trial in 2015. This is one of the few cases arising out of the recent financial crisis to have gone all the way to trial.

The judgment was entered in favor of the Federal Housing Finance Agency (“FHFA”) against Nomura and Royal Bank of Scotland. This case related to residential mortgage -backed securities (“RMBS”) that defendants sold to Fannie Mae and Freddie Mac (which FHFA is the conservator for) between 2005 and 2007, shortly before the housing market collapsed. The district court held that defendants made material misrepresentations in RMBS offering documents in violation of the Securities Act and analogous state securities laws (also known as “Blue Sky laws”), by stating that the mortgages underlying the RMBS had been issued in conformity with underwriting guidelines when, in fact, they had not. Defendants appealed several legal rulings that the district court made prior to and at trial. The Second Circuit ruled in FHFA’s favor on all issues, concluding that the “district court’s decisions here bespeak of exceptional effort in analyzing a huge and complex record and close attention to detailed legal theories ably assisted by counsel for all parties.”

This massive case involved many legal issues and resulted in a district court opinion of more than 300 pages, and a Second Circuit opinion of over 100 pages. The most interesting issues revolved around the question of “negative loss causation.” One of defendants’ main arguments was that their misrepresentations did not “cause” the disastrous decline in value of the securities they sold, and that the broader market collapse was entirely to blame.

Section 12 of the Securities Act provides an affirmative defense to defendants who can establish that some or all of the investor’s losses were not caused by the defendant’s misrepresentations. Here, defendants argued that they were not liable for the decrease in value of FHFA’s RMBS because the entirety of their losses “were attributable to macroeconomic factors related to the 2008 financial crisis and not attributable to [defendants’] misrepresentations.” The Second Circuit rejected this argument because it determined that this was a case where a “marketwide economic collapse is itself caused by the conduct alleged to have caused a plaintiff’s loss.” As the district court determined, the “shoddy mortgage loan origination practices” that defendants misrepresented “contributed to the housing bubble” that created the financial crisis that, in turn, contributed to defendants’ losses.

The Second Circuit also rejected defendants’ argument that their misstatements could not have caused FHFA’s losses because the securities sold here played only a “tiny” role in causing the financial crisis. As the Second Circuit explained, “[f]inancial crises result when whole industries take unsustainable systemic risks. … Defendants may not hide behind a market downturn that is in part their own making simply because their conduct was a relatively small part of the problem.”

This loss causation ruling was based in part on the “heavy” burden that defendants have under the Securities Act to prove that their actions did not cause the plaintiff’s losses. Courts should therefore “presume[e] absent proof to the contrary that any decline in value is caused by the misstatement or omission in the Securities Act context.” Under this “negative causation” standard, “any difficulty separating loss attributable to a specific misstatement from loss attributable to macroeconomic forces benefits the plaintiff.” The court’s decision here thus helpfully explains how difficult it is for defendants to avail themselves of the negative causation defense under the Securities Act.

The Second Circuit also rejected defendants’ attempt to raise the reasonable care defense that is available under the Securities Act. The court held that “no reasonable jury could find that Defendants exercised reasonable care.” This decision was based in part on the deficiencies in the particular due diligence practices that defendants used to review the loans underlying the RMBS at issue in this case. Defendants argued that their due diligence efforts were no worse than procedures being applied at the time across the entire mortgage securitization industry. The court rejected that argument, explaining that “[t]he RMBS industry in the lead up to the financial crisis was a textbook example of a small set of market participants racing to the bottom to set the lowest possible standards for themselves.” Because of this danger, an industry is not allowed to set its own standards of care. Rather, “[c]ourts must in the end say what is required.” The Second Circuit’s analysis here was therefore “only informed by industry standards, not governed by them.” Because of the rampant irresponsible behavior of the mortgage industry that led to the financial crisis, the court concluded that “even if Defendants’ actions on the whole complied with that industry’s customs, they yielded an unreasonable result in this case.”

The issues of causation in the context of a marketwide downturn and compliance with mortgage industry standards that the court addressed here have been raised in many cases arising out of the financial crisis. In agreeing with the district court’s ruling in favor of FHFA, the Second Circuit ruled authoritatively that defendants’ arguments on these issues cannot shield them from liability under the Securities Act.

Another Post-Halliburton II Second Circuit Victory For Pomerantz in Barclays PLC

Attorney: Tamar A. Weinrib
Pomerantz Monitor November/December 2017

Several years ago, in a case known as Halliburton II, the Supreme Court reaffirmed the so-called “fraud on the market” theory, which allows investors in securities fraud class actions to establish reliance on a class-wide basis. If the company’s stock traded on an efficient market that reacted quickly to the release of material information by the company, investors are entitled to a “presumption” that they all relied on the defendants’ misstatements, because they would have affected the price at which they bought their stock.

However, Halliburton II also notably allowed defendants the right to try to rebut this presumption of reliance at the class certification stage, by showing that the market for the company’s shares was not, in fact, efficient. Since then, a mountain of ink has been spilled over the question of who has to prove what, and how, on class certification motions that turn on market efficiency.

In November, Pomerantz achieved another seminal post-Halliburton II victory in the Second Circuit for investors in Strougo v. Barclays PLC, where the Second Circuit affirmed the district court’s decision granting plaintiffs’ motion for class certification. The case concerns defendants’ misrepresentations and concealment of risks involving its management of its LX “dark pool,” a private trading platform where the size and price of the orders are not revealed to other participants. Pomerantz is lead counsel for a class of investors who purchased Barclays’ American Depository Shares (“ADS”) and lost hundreds of millions of dollars when the truth about Barclays’ management of its dark pools came to light.

The district court rejected defendants’ argument that to show market efficiency, plaintiffs must provide event studies showing that the market price of the company’s stock price reacted quickly to the disclosure of new material information about the company. While plaintiffs did in fact proffer an event study, the court held – consistent with a vast body of case law – that no one measure of market efficiency was determinative and that plaintiffs could demonstrate market efficiency through indirect evidence. In so holding, the court observed that event studies are usually conducted across “a large swath of firms,” but “when the event study is used in a litigation to examine a single firm, the chances of finding statistically significant results decrease dramatically,” thus not providing an accurate assessment of market efficiency. The district court found, after extensive” analysis, that plaintiffs sufficiently established market efficiency indirectly, and thus direct evidence from event studies was unnecessary.

Leaving no ambiguity, the Second Circuit’s decision affirming that of the district court cited its own recent decision in Petrobras—another Pomerantz victory—and stated that, “We have repeatedly—and recently—declined to adopt a particular test for market efficiency.”

This decision is a significant win for plaintiffs as it conclusively holds that “direct evidence of price impact … is not always necessary to establish market efficiency.” The Court further made clear that the burden on plaintiffs is not “onerous” and that there would be little point to considering factors looking at indirect evidence of market efficiency if they only came into play after a finding of direct efficiency through an event study.

The Second Circuit also put an end to efforts by defendants to minimize their burden of rebuttal, making it abundantly clear that defendants seeking to rebut the presumption that investors rely on prices set on an efficient market must do so by a preponderance of the evidence. In so holding, the Second Circuit recognized that the presumption of reliance would be of little value if defendants could overcome it easily. Specifically, the Court —pointing to language in Halliburton II, the Supreme Court decision addressing the issue— stated that defendants could only rebut the presumption of reliance by making a showing that “sever[ed] the link” between the mis- representation and the price a plaintiff paid and that any such evidence must be “direct, more salient evidence” and held that it would be inconsistent with Halliburton II to “allow defendants to rebut the Basic presumption by simply producing some evidence of market inefficiency, but not demonstrating its inefficiency to the district court.” The Court made clear that to rebut the Basic presumption, the burden of persuasion properly shifts to defendants, by a preponderance of the evidence. The

Court placed the burden of showing there is no price impact squarely upon defendants and confirmed that plaintiffs have no burden to show price impact at the class certification stage.

Jeremy Lieberman, Co-Managing Partner of Pomerantz, commented: “We are very gratified by the Second Circuit’s decision. In reaching this and the Petrobras decision this past summer, the Second Circuit has unambiguously reaffirmed Halliburton II and Basic’s guidance that class certification for widely traded securities such as Barclays and Petrobras is a “common sense” proposition. For too long, defendants have tried to obscure this guidance by attempting to require arcane event studies at the class certification stage, which had little to do with the merits of the case, or the damages suffered by investors. This decision debunks that effort, providing a far easier and more predictable path for securities class actions plaintiffs going forward.

The Barclays and Petrobras decisions will likely form the bedrock of securities class certification jurisprudence for decades to come. In successfully litigating both appeals, Pomerantz is continuing its more than eighty years of trailblazing advocacy for securities fraud victims.”

Pomerantz Secures Reversal In Ninth Circuit In Atossa Genetics Action

Attorney: Michael J. Wernke
Pomerantz Monitor September/October 2017

In a decision issued by the Ninth Circuit on August 18, 2017, Pomerantz scored a major victory for investors in the securities class action against Atossa Genetics, Inc. This is the latest in a series of cases concerning drug companies’ failure to disclose accurately the regulatory approval status of their products. In Atossa, the company represented that two of its cancer screening tests, which were its main source of revenue, had been approved by the FDA, but, in fact, neither had been approved. When the truth finally came out, Atossa’s share price plummeted by more than 46%.

The Ninth Circuit held that the complaint pleaded facts establishing that the company’s statements were materially misleading, in violation of Section 10(b) of the Securities Exchange Act, and reversed the district court’s dismissal of the claims Pomerantz brought on behalf of investors.

Atossa develops and markets products used to detect pre-cancerous conditions that foreshadow the development of breast cancer. At issue in the case are Atossa’s statements concerning FDA clearance of its MASCT System and ForeCYTE Test, which it marketed as being able to detect breast cancer. Our complaint alleges that Atossa’s CEO misled investors by repeatedly stating that the MASCT System and ForeCYTE Test had been approved by the FDA for cancer screening. In truth, the ForeCYTE Test had never been approved. While the MASCT System had been FDA-cleared as a collection device for tissue samples, Atossa was marketing it as part of the cancer screening test. Moreover, Atossa had materially altered the MASCT System but never sought the required updated FDA clearance. Defendants also misled investors by concealing an FDA Warning Letter that demanded that the company cease marketing the ForeCYTE Test as FDA-cleared. Investors were injured when, on October 4, 2013, Atossa publicly disclosed that the FDA demanded that it recall the MASCT System and ForeCYTE Test, admitting that the ForeCYTE Test has not been cleared or approved by the FDA for any purpose and that the MASCT System had never been approved for cancer screening.

Reversing the district court’s dismissal, the Ninth Circuit held that Pomerantz’s complaint adequately alleges that the CEO’s statements that the ForeCYTE Test was “FDAcleared” were materially misleading because they misrepresented the true status of the test. It had never been approved by the FDA, which was material to investors because the test was Atossa’s main source of revenue. Defendants asserted that the company had disclosed in prior SEC filings that the ForeCYTE Test was a type of diagnostic test that did not require FDA clearance, but likely would require such clearance in the near future. The court rejected the argument that this constituted adequate disclosure, because the prior statements did not contradict the CEO’s assertions of FDA approval but, rather, highlighted why his statements were misleading. “That the FDA did not require clearance at the time of the IPO, does not indicate that the ForeCYTE test was not cleared. … If the FDA was likely to start requiring clearance, then surely a reasonable investor would care whether Atossa’s test was FDA-cleared.”

The court also found materially misleading Atossa’s SEC filing that purported to provide notice of the FDA Warning Letter that the company received. While the notice stated that the company received a Warning Letter and identified the FDA’s concerns regarding the modifications to the MASCT System that required a new clearance application, it left out the FDA’s concerns about the ForeCYTE Test lacking FDA clearance. The court rejected defendants’ argument that the notice was not misleading because it stated that the Warning Letter identified “other matters” and that until they were resolved Atossa may be subject to additional regulatory action. For cautionary language to cure an otherwise misleading statement, it must be a forward-looking statement and must be specific enough such that “reasonable minds could not disagree that the challenged statements were not misleading.” The court found that the misleading part of the notice concerned past facts concerning FDA clearance and the FDA’s findings, and the cautionary language was insufficient because it was “vague enough to cover any concern the FDA might have related to Atossa.”

The Ninth Circuit remanded the case to the district court for further proceedings consistent with the court’s decision.

Attorneys Marc I. Gross and Michael J. Wernke were involved in the appeal.

Supreme Court To Decide Whether All Whistleblowers Are Protected By The Dodd-Frank Act

Attorney: Omar Jafri
Pomerantz Monitor September/October 2017

Next term, the Supreme Court has agreed to resolve a split of authority among the federal courts of appeals on whether an employee who blows the whistle on corporate misconduct internally, but has not yet registered a formal complaint with the SEC, is protected by the anti-retaliation provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”).

Section 21F of the Exchange Act, added by Dodd-Frank, directs the SEC to pay awards to individuals who provide information to the SEC that forms the basis of a successful enforcement action, and prohibits employers from retaliating against such whistleblowers for reporting violations of the securities laws. Section 21F defines a “whistleblower” as “any individual who provides . .  .information relating to a violation of the securities laws to the Commission . . . ” This definition limits whistleblowers to people who actually provide information to the SEC; but subdivision (iii) of the anti-retaliation provisions protects any employee who makes disclosures to the SEC or makes “disclosures that are required or protected under the Sarbanes-Oxley Act of 2002 [“SOX”], . . . the Securities Exchange Act of 1934 . . . and any other law, rule, or regulation subject to the jurisdiction of the Commission.” So, the question is whether the anti-retaliation provisions apply to people who may not fall within the definition of whistleblowers under the Act.

In 2013, the manager of G.E. Energy in Iraq filed a lawsuit against the company pursuant to the antiretaliation provisions of Dodd-Frank. He alleged that he was fired because he reported to senior corporate officers that the company had engaged in corruption to curry favor with a government official in an effort to negotiate a lucrative business deal. When he was fired he had not (yet) reported the violations to the SEC. The Fifth Circuit affirmed the dismissal of his complaint, holding that the plain and unambiguous meaning of the statutory term “whistleblower” did not include anyone who had not yet reported any corporate misconduct to the SEC. It rejected the argument that the anti-retaliation provision was broader than the statutory definition of a whistleblower because it was plausible that an employee could simultaneously report corporate misconduct to both the company and the SEC, thus qualifying for protection. Based on this far-fetched hypothetical scenario, the Fifth Circuit refused to defer to the SEC’s contrary interpretation, and held that the statute’s plain and unambiguous language precluded its application to those who had only reported corporate misconduct to management.

Most federal courts, including the Second and Ninth Circuits, have disagreed with the Fifth Circuit’s reasoning. These courts have concluded that the anti-retaliatory provisions of the statute protect people who are protected or required under SOX, even if they do not meet the statutory definition of a whistleblower. They have held that the anti-retaliation provisions are, at least, in tension with each other if not independently ambiguous, justifying deferring to the SEC’s judgment that internal whistleblowers are protected by Dodd-Frank.

The Fifth Circuit’s reasoning would have an especially dramatic effect on auditors and attorneys, who are prohibited by SOX and SEC rules from filing reports with the Commission unless they first report corporate misconduct to senior managers or to a committee of the board of directors of the company. If they can be picked off before they have a chance to report violations to the SEC, companies may be able to stifle them. Auditors and attorneys played a central role in the Enron and other scandals, and the purpose and intent of SOX is to also regulate the behavior of these professionals. The Fifth Circuit utterly failed to address the impact of its decision on the obligations imposed by SOX on auditors and attorneys.

Supremes To Decide Whether State Courts Still Have Jurisdiction Over Securities Act Class Actions

Attorney: H. Adam Prussin
Pomerantz Monitor September/October 2017

The Exchange Act provides that federal courts have “exclusive” federal jurisdiction over all claims brought under the act, meaning that those claims, including anti-fraud claims, cannot be brought in state courts. In contrast, the Securities Act provides for “concurrent jurisdiction” of claims brought under that act, meaning that such claims, including claims relating to initial public offerings, can be brought in either federal or state courts. At least, that’s what we thought until now.

At the end of its last term, in a case called Cyan, the Supreme Court granted cert in a case involving SLUSA, the “Securities Law Uniform Standards Act.” That law was primarily designed to limit investors’ ability to bring class action claims under state law concerning securities transactions (so-called “covered class actions”) in state courts, rather than under federal securities laws in federal courts. To accomplish this goal, SLUSA requires that “covered class actions,” including state law claims involving misstatements in securities transactions, must be litigated in federal court under federal law. The act was passed in response to complaints that securities plaintiffs were recasting federal securities laws claims as state law claims in order to avoid the enhanced pleading requirements for federal claims imposed by the Private Securities Litigation Reform Act (“PSLRA”). The practical effect is that it is no longer possible to bring “covered class actions” under state law in either state or federal court; the claims must be made under the federal securities laws, in federal court, subject to the strictures of the PSLRA – or not at all.

But defendants have also been trying, with mixed success, to use SLUSA as a weapon to keep federal Securities Act claims out of state court as well; some companies and other securities defendants view state courts (so-called “judicial hellholes”) as overly sympathetic to securities laws claims.

The hook defendants have been using to advance this argument is a provision in SLUSA that amends section 22 of the Securities Act to provide that federal jurisdiction over Securities Act claims shall be “concurrent with State and Territorial courts, except as provided in section 77p of this title with respect to covered class actions.”

Although there have been no federal appeals courts rulings on what this exception means, there have been dozens of conflicting rulings by federal district courts and state courts, most notably in the two states where most securities class action litigation is conducted: California and New York. Courts in New York tend to read the exception to mean that state courts no longer have jurisdiction over covered class actions alleging violations of the Securities Act. Others, such as a California state appellate court in Luther v. Countrywide Financial, read the exemption language not as creating a new exemption for all covered class actions, but simply as acknowledging the exceptions to state court jurisdiction that are actually established in section 77p of SLUSA. The Countrywide court explained that

Section 77p does not say that there is an exception to concurrent jurisdiction for all covered class actions. Nor does it create its exception by referring to the definition of covered class actions in section 77p(f)(2). Instead, it refers to section 77p without limitation, and creates an exception to concurrent jurisdiction only as provided in section 77p “with respect to covered class actions.

The Countrywide court held that there was nothing in section 77p that eliminated state court jurisdiction over claims brought solely under the Securities Act, and that therefore SLUSA’s exception to concurrent jurisdiction did not apply in such cases. Yet, the exemption is codified in the jurisdictional provision of the Securities Act, so it must mean that concurrent jurisdiction does not exist for some claims under the Act. What those claims are is a puzzlement that only the Supreme Court can resolve.

It goes without saying that the drafting of this confusing exemption to state court jurisdiction was not among Congress’s finest hours. But given that the overriding purpose of SLUSA was to keep misrepresentation claims under state law out of state court, it would be anomalous if this provision were construed as a backhanded way to restrict jurisdiction over federal claims as well.

Kokesh v. SEC: A Door Is Closed, But Windows Are Opened

Attorney: Justin Solomon Nematzadeh
Pomerantz Monitor September/October 2017

In Kokesh v. Securities and Exchange Commission, the Supreme Court recently applied the five-year statute of limitations to claims by the SEC for disgorgement of ill-gotten profits from violations of the federal securities laws. Dealing a blow to the SEC’s enforcement powers, the Court held that the disgorgement remedy is not primarily remedial but more closely resembles a “punishment” subject to the five-year limitation period. By forcing the SEC to move more quickly in these cases, the Kokesh opinion has actually helped plaintiffs in class actions and individual lawsuits. It should motivate the SEC to file actions at an earlier date, and thereby expose securities law violations sooner, better enabling private plaintiffs to file their own actions within the five-year statute of limitations that private plaintiffs face in bringing class actions and individual lawsuits.

In 2009, the SEC commenced an enforcement action against Charles Kokesh, who owned two investment advisory firms, seeking civil monetary penalties, disgorgement, and an injunction. The SEC alleged that between 1995 and 2009, Kokesh misappropriated $34.9 million from four business development companies and concealed this through false and misleading SEC filings and proxy statements. After a five-day trial, the jury found that Kokesh violated securities laws. The district court decided that $29.9 million of the disgorgement request resulting from Kokesh’s violations outside the limitations period was proper because disgorgement was not a “penalty” under §2462. The Tenth Circuit affirmed this decision, agreeing that disgorgement is neither a penalty nor forfeiture, so §2462 did not apply. The Court granted certiorari to resolve a circuit split on this issue, and in a unanimous decision authored by Justice Sotomayor, the Court reversed the Tenth Circuit.

Beginning in the 1970s, courts ordered disgorgement in SEC enforcement actions to deprive “‘defendants of their profits in order to remove any monetary reward for violating securities laws and to ‘protect the investing public by providing an effective deterrent to future violations.’” The Court had already applied the five-year statute of limitations for any “action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise,” when the SEC sought statutory monetary penalties. Disgorgement would also fall under this if deemed a “fine, penalty, or forfeiture.” A “penalty” is a “punishment, whether corporal or pecuniary, imposed and enforced by the State, for a crime or offen[s]e against its laws.” Whether disgorgement is a penalty hinged on two factors: first, whether the wrong to be redressed is one to the public or to an individual; and second, whether the sanction’s purpose is punishment and to deter others from offending in a like manner, as opposed to compensating a victim for her loss.

First, the Court decided that SEC disgorgement is imposed by courts as a consequence of public law violations. The remedy is sought for violations against the United States—rather than an aggrieved investor. This is why a securities-enforcement action may proceed even if victims do not support it nor are parties. Even the SEC conceded that when “the SEC seeks disgorgement, it acts in the public interest, to remedy harm to the public at large, rather than standing in the shoes of particular injured parties.”

Second, the Court decided that disgorgement is a punishment. Disgorgement aims to protect the investing public by deterring future violations: “[C]ourts have consistently held that ‘[t]he primary purpose of disgorgement orders is to deter violations of the securities laws by depriving violators of their ill-gotten gains.’” Sanctions imposed to deter public law infractions are inherently punitive because deterrence is not a legitimate nonpunitive governmental objective. Moreover, disgorgement is not compensatory. Disgorged profits are paid to the district court, and it is within the court’s discretion how and to whom to distribute the money. District courts have required disgorgement regardless of whether the funds will be paid to investors as restitution: some disgorged funds are paid to victims; other funds are dispersed to the U.S. Treasury.

The Court found unpersuasive the SEC’s primary response that disgorgement is not punitive but instead remedial in lessening a violation’s effect by restoring the status quo. According to the Court, it is unclear whether disgorgement simply returns a defendant to the place occupied before having broken the law, as it sometimes exceeds profits gained from violations. For example, disgorgement is sometimes ordered without considering a defendant’s expenses that reduced the illegal profit. SEC disgorgement is then punitive, not simply restoring the status quo, but leaving the defendant worse off. Although disgorgement can serve compensatory goals, it can also serve retributive or deterrent purposes and be a punishment.

This decision puts limits on the SEC’s use of a favored tool—in recent years, the SEC secured nearly $3 billion in disgorgements, more than double what it received in penalties. But the decision should open doors for civil plaintiffs in class actions and individual lawsuits for violations of the federal securities laws. Within the five-year statute of limitations imposed on private civil plaintiffs, the SEC would now have to reveal to investors securities-law violations by companies and individuals who would be defendants in private lawsuits. This will better equip private civil plaintiffs to sue those defendants in a timely fashion. In any case, disgorgement is not a common remedy for private civil plaintiffs in securities lawsuits. Further, defendants who pay relatively less disgorgement in SEC enforcement actions may have more funds to satisfy parallel private civil lawsuits. Through closing the door on an element of the SEC’senforcement powers, the Court has opened several windows for private civil plaintiffs.

Second Circuit Reconsiders “Personal Benefit” Requirement

Attorney: Marc C. Gorrie
Pomerantz Monitor September/October 2017

As the Monitor has reported, in the past year there have been numerous developments concerning the requirements for criminal liability for insider trading. Most recently, in U.S. v. Martoma, the Second Circuit revisited its 2014 decision in U.S. v. Newman and decided that there was no requirement, after all, that the recipient of the leaked information (the “tippee”) be a close relative or friend of the insider who leaked the information (the “tipper”).

The seminal case in this area is the 1983 Supreme Court decision in Dirks v. Securities and Exchange Commission.

There, the Court held that culpability for insider trading can exist if the tipper received a personal benefit for leaking the information, such as when he “makes a gift of confidential information to a trading relative or friend.” The Court did not elaborate on how close the relationship had to be between the tipper and the “trading relative or friend.”

When the Second Circuit decided Newman in 2014, it effectively put the brakes on much of the government’s expansive insider trader enforcement efforts. The Newman court overturned the convictions of two “remote” tippees, who had received the information indirectly from the original tippee. The Newman court held that the government must prove that the tipper had a “meaningfully close personal relationship” with the tippee, and that he expected “at least a potential gain of a pecuniary or similarly valuable nature” to support a finding of criminal liability for insider trading. This heightened standard required a showing that the tipper received some “tangible” benefit other than the satisfaction of rewarding the friend or relative – an interpretation rejected by other circuits. Further, the Second Circuit required that the government must also demonstrate the tippee knew that the tipper breached a fiduciary duty. This can present a major problem if the defendant is a remote tippee, such as colleagues of the original tippee at a brokerage firm, who may have little information of how the information was obtained and under what circumstances.

In Salman v. United States, the Supreme Court affirmed the defendant’s conviction for insider trading, unanimously holding that a jury may infer a personal benefit when a tipper provides inside information to a relative or friend, and that this is sufficient for a finding of criminal liability for insider trading. The Supreme Court went on to address the Second Circuit’s Newman decision, finding that any requirement “that the tipper must also receive something of a ‘pecuniary or similarly valuable nature’ in exchange for a gift to family or friends” is inconsistent with Dirks.

On August 23, 2017, the Second Circuit affirmed the insider trading conviction of Mathew Martoma in a 2-1 opinion holding that the Supreme Court’s decision in Salman effectively overruled Newman’s requirement of a “meaningfully close personal relationship,” but did not disturb Newman’s other requirement that a tippee knew that the tipper breached a duty and received a benefit.

Martoma was a pharmaceutical and healthcare portfolio manager at S.A.C. Capital Advisors, LLC, (“S.A.C.”), a former group of hedge funds founded by Steven A. Cohen. During the course of his employment,  he acquired shares of Elan and Wyeth, two companies that were developing an experimental Alzheimer’s drug. Martoma executed these trades based on information he obtained from the chair of the safety monitoring committee for the drug’s clinical trial, Dr. Sidney Gilman. The two of them met in approximately 43 consultations where, for some, Martoma paid Gilman $1,000 per hour. Dr. Gilman disclosed trial results and other confidential information to Martoma during these consultations.

Martoma and Gilman met twice, just before a conference at which Gilman was to present the clinical trial results of the new drug. After these two meetings but before the conference, S.A.C. began to reduce its positions in Elan and Wyeth. Following Gilman’s July 29 presentation disclosing that the drug failed to improve cognitive function in a test of 234 Alzheimer’s patients after 18 months of treatment, the share prices of Elan and Wyeth plummeted. The trades that Martoma’s hedge fund had made in advance of the presentation resulted in approximately $80 million in gains and $195 million in averted losses.

Martoma was convicted of insider trading and during his appeal, the Supreme Court decided Salman, doing away with the personal benefit requirement. Martoma argued that the jury instructions improperly ignored that he did not have a close personal or family relationship with the tipper.

The Second Circuit held that the logic of Salman meant that “Newman’s meaningfully close personal relation- ship requirement can no longer be sustained.” The Court held that “the straightforward logic of the giftgiving analysis in Dirks, strongly reaffirmed in Salman, is that a corporate insider personally benefits whenever he discloses inside information as a gift with the expectation that the recipient would trade on the basis of such information or otherwise exploit it for his pecuniary gain” – whether the recipient has a close personal relationship with the tipper or not.

Acknowledging a vigorous dissent that argued that Salman did not overrule Newman’s “meaningfully close personal relationship” requirement where inferring a personal benefit from a gift, the majority concluded that though the government must still prove that the tipper received a personal benefit, a “meaningfully close personal relationship” need not exist between tipper and tippee.

Though the Second Circuit dispensed with Newman’s “meaningfully close personal relationship” requirement, the other controversial Newman requirement, that the tippee knew the tipper provided inside information in exchange for some benefit, apparently remains intact. Additionally, it appears that one fact-sensitive evidentiary foray was replaced with another, with the government now having to prove “the expectation that the recipient would trade” based on inside information. En banc review of Martoma may also be on the horizon, as the dissent contended the Martoma court could not overrule Newman without convening en banc.

Corporate Governance & Therapeutics

Attorney: Gabriel Henriquez
Pomerantz Monitor July/August 2017

On September 16, 2015, Lithia Motors, Inc. filed a Form 8-K with the SEC announcing that Sidney DeBoer, its founder, controlling shareholder, CEO, and Chairman, would step down as an executive officer of the company and would receive annual compensation—for life— in consideration for his past services. According to a “Transition Agreement” between Lithia and DeBoer, the company would pay him $1,060,000 and a $42,000 car allowance annually for the rest of his life, plus other benefits. The payments under the Transition Agreement were in addition to the $200,000 per year that DeBoer receives for continuing to serve as Chairman.

Although the company annually submitted its executive compensation packages to a (non-binding) shareholder vote, it did not do so this time, even though the agreement was tainted by obvious self-dealing by the controlling shareholder. Companies usually appoint a special committee of independent directors to negotiate contracts with a CEO or controlling shareholder; but here, Sidney DeBoer and his son, the current CEO, Bryan DeBoer, negotiated all the material terms. The company’s Compensation Committee, consisting of four directors who are purportedly “independent,” had minimal input into the terms of the Transition Agreement. Once it was handed to them, they rubber-stamped it with only minor changes, which had been mostly proposed by, and favorable to, Sidney DeBoer.

Our client, as well as another one of Lithia’s shareholders, filed derivative complaints on behalf of Lithia in Oregon state court, where Lithia is headquartered. We alleged that the board of directors breached its fiduciary duties by approving the Transition Agreement without any meaningful review, injuring the company and its shareholders. We also alleged that the board was not independent and was conflicted due to the existence of longstanding relationships between the purportedly independent directors and Sidney DeBoer, as well as significant compensation paid to the directors, which they would lose if Sidney DeBoer decided to remove them from the Board. At the time of the approval of the Transition Agreement, Lithia’s Audit and Compensation Committees (both of which reviewed the agreement before it was entered into) had the same four members; the only difference was which director served as chair of the respective committees. Each of the four members had close personal ties to Sidney DeBoer.

Documents obtained by plaintiffs during the discovery phase of the litigation revealed that Sidney DeBoer: routinely attended meetings of the Compensation Committee responsible for setting his compensation and the compensation of Bryan DeBoer; was directly involved in setting compensation for management and the Board; and single-handedly made determinations regarding the composition of the Board, and continues to dominate and hold tight command over Board decisions. If Sidney DeBoer did not agree with how the Compensation Committee would vote on a particular matter, he would instruct to hold off on the vote until each director had a discussion with him first. The consequences of this lack of checks and balances was clear. The directors approved an agreement that committed Lithia to paying lavish sums indefinitely, regardless of whether Sidney DeBoer provided services effectively for Lithia, or even if he provided no services at all.

This circumstance highlights the need to have an independent board of directors able to effectively monitor management and corporate success without undue influence by the CEO, Chairman, controlling shareholder— or all three, as was the case here.

Through extensive litigation efforts, Pomerantz, together with its co-counsel, was able to extract corporate governance therapeutics that provide substantial benefits to Lithia and its shareholders and redress the wrongdoing alleged by plaintiffs. For example, the Board will be required to have at least five independent directors as defined under the New York Stock Exchange rules by 2020; all future life-time compensation contracts for named executive officers exceeding $1 million per year must be submitted to shareholders for approval, and will be reviewed by disinterested members of the Audit Committee; the Audit and Compensation Committees shall each have at least one independent director who is not a member of both committees; a four-consecutive-year term limit shall be imposed for the chair of committees of the Board; a 15-year term for shall be imposed for service as an independent director on Lithia’s Board; Lithia will also publicly disclose, in information accompanying its annual proxy statement and accessible on Lithia’s website, the most recent five years’ compensation of the named executive officers. Finally, but perhaps most importantly with regards to the issue at hand, the settlement calls for the Transition Agreement to be reviewed by an independent auditor who will determine whether the annual payments of $1,060,000 for life toSidney DeBoer are reasonable. Lithia has agreed to accept whatever decision the Auditor makes.


United Airlines Rewards Executives Who Bribed Public Official -- Really?

Attorney: Gustavo F. Bruckner
Pomerantz Monitor July/August 2017

What should happen when the top executives of a corporation are implicated in an illegal scheme that brings disrepute to the company and results in millions of dollars in fines and legal costs? You might expect them to be terminated with haste and efforts made to seek from them the costs incurred by the corporation due to their wrongdoing. But in the case of United Airlines, you would be wrong.

In 2015, Jeffery A. Smisek, then United Continental’s CEO, was the subject of a government investigation regarding a bribery scheme with then-New York/New Jersey Port Authority chairman David Samson. Samson had complained to Smisek that there was no direct route from the Newark, New Jersey airport to the vicinity of his South Carolina vacation home and asked whether United could revive the company’s previously discontinued, money-losing direct flight from Newark to Columbia, South Carolina.

At first, Smisek balked. Samson then twice threatened to block Port Authority consideration of one or more of the company’s planned projects. As a result, Smisek agreed to accommodate Samson with the requested direct flight to South Carolina. Operating twice a week, the Newark-to-Columbia route—which Samson reportedly liked to refer to as “the chairman’s flight”—was, on average, only half full, and remained unprofitable for United Continental during the 19 months of its revived existence. The route ultimately lost approximately $945,000 for the company.

Samson entered into a plea agreement with the U.S. Department of Justice wherein he pleaded guilty to bribery or misusing his official authority to pressure United Continental to reinstitute the flight. Samson was ultimately sentenced to one year of home confinement, four years of probation, and a fine of $100,000.

As a result of the bribery scheme with Samson, United Continental was forced to pay a $2.25 million penalty to the United States Treasury and another $2.4 million to the SEC, as well as to expend untold amounts in undertaking an internal investigation in conjunction with federal authorities.

Rather than firing Smisek for cause, the United Continental Board of Directors instead elected to sign a separation agreement awarding Smisek a severance package worth an estimated $37 million dollars. Other implicated executives were also allowed to resign and were given severance packages. Notably, all of the severance packages were granted well before the company concluded a non-prosecution deal with federal authorities and before the company was made to pay fines regarding the bribery scheme. One executive did have his bonus cut, but was then promoted from Senior Vice President of Network Planning, to Executive Vice President and Chief Operations Officer.

Our client, a United shareholder concerned by the lack of integrity at the top, initiated a request for a books and records inspection pursuant to Delaware statute to determine whether it was appropriate to seek clawback of any ill-gotten compensation. Documents received in response to this request indicated that the United Continental Board of Directors never truly considered instituting a clawback of compensation paid to Smisek and the other executives involved in the bribery scheme, despite their egregious and illegal behavior. Rather than penalizing Smisek by, for example, terminating his previously awarded unexpired stock options and clawing back prior compensation, the company rewarded him with a very handsome separation package—despite ongoing investigations by agencies of the federal government.

Our client then made a demand for legal action upon the United Continental Board of Directors, specifically asking the Board to “institute legal action for damages against all responsible officers and directors.” The Board rejected the demand. Their reasoning was astonishing: that “to allow unfettered ‘discretion to recoup compensation whenever the Board determines misconduct, willful or otherwise, has occurred,’ where such discretion is out of step with industry norms, would make it difficult for United to recruit and retain top talent, particularly at the senior management level.”

Rather than punishing the executives who authorized bribing public officials, the company gallingly asserted it would be bad for business to do so, and instead rewarded them with big bucks and benefits. Stockholders expect that, at a minimum, corporate officers act in accordance with the law. To not clawback compensation in the face of egregious and illegal behavior sends the message that officers can violate the law with impunity.

Pomerantz initiated a lawsuit for our client, brought derivatively on behalf of the company, against the United Board for refusing to clawback compensation paid to the senior executives involved in the bribery scheme despite being empowered to do so by the company’s policies, and against Smisek for restitution and disgorgement of ill-gotten profits. The Delaware Court of Chancery will determine if the payments were properly made or if the officers should have jumped the airline without the golden parachutes. Fasten your seatbelts, this will get bumpy.

Supremes: The Filing Of A Class Action Does Not “Toll” The Statute Of Repose

Attorney: H. Adam Prussin
Pomerantz Monitor July/August 2017

In one of its last decisions of the term, regarding California Public Employees Retirement System v. ANZ Securities, Inc., the Supreme Court ruled, 5-4, that the three-year limitations period for filing claims under the Securities Act cannot be “tolled” by the filing of a class action. That means that even if a class action is filed, investors who are part of the class cannot sit back for three years and wait to see how the action turns out. Once a statute of repose is about to expire, it is every man, woman and institution for himself.

A “statute of repose” is different from a statute of limitations. The Securities Act has two limitations periods: actions must be brought one year from the date investors discovered the wrongdoing; and, regardless of when the wrongdoing was discovered, no case can be filed more than three years from the date the securities in question were first offered to the public. The one-year period has long been considered to be a statute of limitations, which is intended to force potential claimants to act with reasonable promptness and diligence to pursue their claims. The concept of reasonableness opens the door to the concept of “equitable tolling”: the time limitation clock stops running under certain circumstances that might justify claimants to delay before pursuing their rights. One such justification is fraudulent concealment of the wrongdoing by the defendant. If the facts are concealed, how can potential claimants be blamed for not immediately realizing they had claims to pursue?

Another potential justification for delay is the filing of a class action that seeks to cover the investors’ claims. If that happens, an investor in the class would be justified not to pursue his own individual action right away. In fact, class actions were invented in part to prevent the proliferation of unnecessary, duplicative individual actions by hundreds or even thousands of injured parties. Decades ago, the Supreme Court endorsed this justification for delay in the case American Pipe, holding that if someone files a class action raising a particular claim, the statute of limitations for that claim is “tolled” for all class members, meaning that the limitations clock stops running during the tolling period. If the class action is later dismissed, or if class certification is denied, or if class members want to opt out of a proposed settlement of the case, they can do so and bring their own individual action without worrying that the statute of limitations has run out on them while they waited for the class action to be resolved. This legal principle is called “American Pipe tolling.”

But what about the three-year limitations period for Securities Act claims? Here the defendant in the California Public Employees Retirement System (“CalPERS”) case argued that this period was not a statute of limitations but a statute of “repose,” designed not only to assure prompt action by claimants, but also to give potential defendants the assurance that, after a certain period, no (more) claims can be raised that relate to a given transaction. In CalPERS, the Supreme Court has now agreed with this argument, ruling that this purpose would be undermined if the three-year limitation period could be “tolled” for any reason, including the pendency of a class action. It therefore refused to apply American Pipe tolling to the three year limitation period provided by the Securities Act.

As an aside, it is unclear to us, as well as to the four dissenters on the Supreme Court, what kind of “repose” defendants can enjoy if they are already being subjected to a class action asserting all the investors’ claims. But never mind.

The CalPERS decision will have dramatic consequences in securities class actions. For one thing, if a class was not certified after three years had expired, putative class members used to be able to bring their own action. Not anymore. For another thing, if after three years the lead plaintiff agrees to a settlement that investors believe is inadequate, they no longer can “opt out” at that point and bring their own action. That’s exactly what happened to CalPERS itself. It didn’t like the proposed settlement, opted out of the class action, and brought its own action – which was summarily dismissed for violating the statute of repose. In short, opting out of a Securities Act class action after three years is no longer an option. To protect themselves against the absolute three-year bar, investors will have to file their own individual actions within the three year period, even if the class action is still pending and unresolved.

The implications of the CalPERS decision will not be limited to claims under the Securities Act. Claims under the Exchange Act, including under its antifraud provisions, are subject to a five-year statute of repose; and many other statutes also have such “drop dead” “repose” periods.

The CalPERS decision poses a challenge for institutional investors and those advising them. They will now have no choice but to monitor all securities class actions in which they are class members, and in which they have significant  losses; and if the actions are still unresolved when the statute of repose is about to expire, they will need to consider whether they should file their own individual actions, to protect themselves. Given that most securities class actions take years to resolve, this is a dilemma that will confront many institutional investors in many cases.

Not surprisingly, newly minted Justice Gorsuch voted with the 5-4 majority, proving once again that elections have consequences.

Pomerantz Secures The Right Of BP Investors To Pursue “Holder Claims”

Pomerantz Monitor July/August 2017

Since 2012, Pomerantz has pursued ground-breaking claims on behalf of institutional investors in BP p.l.c. to recover losses in BP’s common stock (which trades on the London Stock Exchange) stemming from the 2010 Gulf oil spill. The threshold challenge was how to litigate in U.S. court in the wake of the Supreme Court’s 2010 decision in Morrison v. Nat’l Australia Bank Ltd., 561 U.S. 247 (2010), which barred recovery for losses in foreign traded securities under the U.S. federal securities laws.

Pomerantz blazed a trail forward, in a series of cutting edge wins. In 2013, we survived BP’s first motion to dismiss, securing the rights of U.S. institutional investors to pursue English common law claims, seeking recovery of losses in BP common stock, in U.S. court. The court agreed that the forum non conveniens doctrine did not require the cases to be refiled in England, the Dormant Commerce Clause of the U.S. Constitution did not bar the claims, and we adequately alleged reliance on the fraud based on facts developed from our clients’ investment managers. In 2014, we survived BP’s second motion to dismiss, securing the same rights for foreign institutional investors, by again defeating BP’s forum non conveniens argument, as well as its argument that a U.S. federal statute, the Securities Litigation Uniform Standards Act, should bar the claims. Together, these victories secured the core English law deceit case for over 100 institutional investors from four continents.

In 2015, Pomerantz embarked on an effort to also secure the rights of investors who retained shares of BP stock because of the fraud, an approach typically referred to as a “holder claim.” The U.S. Supreme Court has barred pursuit of “holder claims” under the U.S. federal securities laws since Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975). Nevertheless, we developed extensive facts from our clients and their investment managers, consulted with an English law expert, and sought to amend their complaints to add a “holder claim” theory under their English legal claims. We had to file a motion seeking leave of court to amend most of our clients’ complaints, which BP opposed. The court granted our motion, and we filed all the amended complaints by 2016.

BP’s third motion to dismiss followed, seeking dismissal of the “holder claims” on two principal grounds – damages and reliance. Pomerantz Partner Matthew Tuccillo once again oversaw the legal briefing, which spanned over 250 pages of briefs and expert declarations by both sides, and he handled the multi-hour oral argument before Judge Keith Ellison in the U.S. District Court for the Southern District of Texas. Both issues were hotly contested.

First, BP argued that, as a matter of “logic,” no investor was damaged by retaining shares in reliance on the postspill fraud, when BP understated the scope of the oil spill, because had BP truthfully disclosed its scope up-front, the stock would have immediately bottomed out, leaving no time to sell at any price higher than the bottom. BP’s argument had support among U.S. case law, including a decision by the Fifth Circuit Court of Appeals. However, as Mr. Tuccillo argued to Judge Ellison, the stock declines in the post-spill period had a complex mix of causes – while some were due to corrections of the post-spill fraud, others were due to corrections of the pre-spill fraud (regarding BP’s safety reforms and upgrades) or general market declines unrelated to any fraud – and English law permits recovery of all such declines after an investor was induced to retain shares that otherwise would have been sold. The court agreed that Pomerantz had alleged cognizable damages, and it rejected BP’s argument.

Second, BP argued that we had not sufficiently alleged our clients’ reliance on the fraud as the reason they retained BP shares. BP argued that, for purposes of a “holder claim,” U.S. Federal Rule of Civil Procedure 9(b) required our clients to allege not only the aspects of the fraud on which they relied and the date(s) on which they would have sold their BP shares, but also the exact number of shares they would have sold and the prices they would have received. Pomerantz argued that level of precision was not required, and the court agreed, holding instead that Rule 9(b) required us to allege with particularity only what actions our clients “took or forewent,” beyond “unspoken and unrecorded thoughts and decisions,” due to the fraud. Applying this still-stringent standard, the court held that certain Pomerantz clients had indeed adequately alleged their reliance on the fraud as the reason they retained already-held shares of BP stock. The court differentiated between clients based on the level of factual details alleged. The court’s order illustrates that it was persuaded that a viable “holder claim” was alleged when a client’s complaint recounted investment notes memorializing not only aspects of the fraud (e.g., BP’s false oil flow rate statements) but also calculations based thereon, resulting conclusions, and an express, contemporaneous decision to continue to  hold BP shares. For these clients, the court agreed that evidence as to the exact amount of damages was more appropriate for a later stage of the case.

These rulings are very significant, given the dearth of precedent from anywhere in the U.S. that both recognizes the potential viability of a “holder claim” under some body of non-U.S. federal law and holds that the plaintiffs attempting one sufficiently alleged facts giving rise to reliance and other required elements of the underlying legal claims. For this reason, we anticipate that the decision rendered in the BP litigation on behalf of our clients will become an important and useful precedent for investor suits.

Petrobras Class Action Clears Major Hurdles In Second Circuit

Attorneys: Murielle Steven-Walsh and Emma Gilmore 
Pomerantz Monitor July/August 2017

In a decision issued by the Second Circuit on July 17, Pomerantz has scored a significant victory for investors in the Petrobras Securities Litigation, one of the largest securities fraud class actions pending in the United States. The court’s decision, which addressed the standards for certifying plaintiff classes in this case, sets important precedent for class action plaintiffs in securities, antitrust and consumer cases.

Pomerantz has asserted claims in this case on behalf of two classes of investors. One class consists of investors in Petrobras equity and note securities, asserting fraud claims under Section 10(b) of the Securities Exchange Act. Because Petrobras is a foreign corporation, the equity securities at issue are Petrobras American Depository Receipts, which represent shares of stock, and which trade on the New York stock Exchange. The note securities are bonds that are not listed on any exchange in the U.S., but trade over the counter. The second class is limited to investors in Petrobras note securities, asserting claims under Sections 11, 12(a)(2) and 15 of the Securities Act. As required by the Supreme Court’s Morrison decision, the classes are limited to investors who acquired Petrobras securities pursuant to transactions that occurred in the United States.

As the Monitor has previously reported, the Petrobras case involves the biggest corruption scandal in the history of Brazil, which has implicated not only Petrobras’ former executives but also Brazilian politicians, including former presidents and at least one third of the Brazilian Congress. The defendants’ alleged fraudulent scheme, nicknamed

Operation Carwash, involved billions of dollars in kickbacks and overstated Petrobras’ assets by tens of billions of dollars. When the truth came out about Petrobras’ criminal scheme, investors lost tens of billions of dollars they had invested in the company.

In February, 2016, the District Court certified both classes, and defendants appealed on multiple grounds. First, they contended that the noteholder claims should not be certified because it would not be “administratively feasible” for the court to determine which noteholders are part of either the Section 10(b) or Section 11 classes because they purchased their notes in U.S. domestic transactions. In their view, because paper records are often difficult to pull together in over the counter transactions, it would not be “feasible” for the court to sort through all of this.

Second, defendants contended that the Section 10(b) class should not have been certified because plaintiffs did not submit event studies proving that the Petrobras ADRs traded on an “efficient” market.

The Second Circuit accepted the appeal, but largely rejected defendants’ arguments, sending the case back to the District Court for further proceedings.

The decision is an important and favorable precedent in several respects.

First, the Second Circuit squarely rejected defendants’ invitation to adopt the heightened “administratively feasible” requirement promulgated by the Third Circuit. It held, instead, that so long as the class is defined by objective criteria, membership in the class is sufficiently “ascertainable,” even if it takes some work to make that determination. The Second Circuit’s rejection of the Third Circuit’s heightened “administratively feasible” standard is not only important in securities class actions, but also for plaintiffs in consumer fraud class actions and other class actions where documentation regarding class membership is not readily attainable.

The Court did, however, conclude that the District Court had not properly analyzed whether the individual issues in determining who is a domestic purchaser under Morrison “predominated” over common questions for noteholder class members. It therefore remanded the case to the District Court to provide such an analysis. But the Second Circuit “took no position” as to whether the District Court may properly certify one or several classes on remand, and in fact acknowledged that “the district court might properly certify one or more classes that capture all of the Securities holders who fall within the Classes as currently defined.” We believe that the record in this case easily supports such a determination.

The Second Circuit also refused to adopt a requirement, urged by defendants, that all plaintiffs seeking class certification of Section 10(b) fraud claims prove, through an event study, that the securities traded in an efficient market. As the Monitor has previously reported, the “efficient market” doctrine allows investors to establish reliance on a class-wide basis; and reliance is an essential element of any Section 10(b) claim. In an efficient market, securities’ trading prices move quickly in response to new information. Disclosure of negative information quickly drives prices down, and vice-versa. The Second Circuit rejected the notion that complicated event studies be submitted by plaintiffs at the class certification stage, reaffirming the Supreme Court’s guidance that the burden for plaintiffs seeking class certification “is not an onerous one.” The Court agreed with plaintiffs that other standard methods for establishing market efficiency are sufficient at the class certification stage, and that “event studies offer the seductive promise of hard numbers and dispassionate truth, but methodological constraints limit their utility in the context of single-firm analyses.”

The Second Circuit’s decision means that antifraud claims asserted on behalf of ADR purchasers will proceed as a class. Further proceedings will be needed only with respect to claims of noteholders.

Attorneys Jeremy Lieberman, Marc Gross, Emma Gilmore, Brenda Szydlo and John Kehoe were involved in the appeal.

Study Shows Drastically Increased Concentration Of Corporate Economic Power


A recent academic study of public corporations in America has produced a picture of dramatically increased business concentration over the past 40 years. The study, done by professors Kahle and Stulz of Arizona State and Ohio State universities, respectively, which was published earlier this year, reveals the following startling facts about corporate

America in 2015 vs. 1975:

• In 1975, there were 4,819 publicly listed U.S. corporations. In 1997 there were 7,507. In 2015 there were only 3,766.

• Despite this decline, the aggregate market capitalization of U.S. public companies is seven times larger, in constant dollars, than it was in 1975. The 2015 mean and median market values of the equity of public companies (in

constant 2015 dollars) is almost 10 times the market values in 1975. In short, although there are far fewer public companies, they are far larger than ever before.

• An ever smaller proportion of public companies are responsible for most of the profits and assets. In 1975, 94 companies accounted for half of the assets of all public companies and 109 companies accounted for half of the net income. In 2015, 35 corporations accounted for half of the assets and 30 accounted for half of the net income.

• Capital expenditures as a percentage of assets fell by half between 1975 and 2015, while R&D expenditure increased fivefold. Capital expenditures are depreciated over time while R&D costs are expensed in the year incurred.

• In 1980, the first year for which the data are complete, the authors found that institutional owners represented 17.7% of ownership of U.S public companies. By 2015, the figure was 50.4%.

• The highest percent of net income paid out to shareholders during the 40-year period between 1975 and 2015 was in 2015. These payouts were not mostly in the form of dividends, but instead, of share repurchases.

It seems as if the “winner take all” phenomenon of outsized financial rewards for the top one percent of the population seems to apply at the corporate level as well.

As wealth becomes more and more concentrated, so too is the influence of the wealthy, not only in the business world but in the political world as well. Particularly after the Citizens United case, super-wealthy individuals and corporations are free to throw their financial weight around.

Other Shoes Keep Dropping At Wells Fargo -- But Is It Enough?

Attorney: Tamar A. Weinrib

Though every attempt was made at first to “blame the little guy,” Wells Fargo executives have finally been called to task for an egregious scandal over fraudulent accounts, with the CEO fired and over $182 million in executive compensation rescinded.

As the Los Angeles Times first revealed back in 2013, and as the Monitor has recently reported, a pervasive culture of aggressive sales goals at Wells Fargo pushed thousands of workers to open as many as 2 million accounts that bank customers never wanted. This happened because low-level, low-wage employees had to meet strict quotas for opening new customer accounts, or risk their positions. To meet these quotas, the employees opened unneeded accounts for customers and forged clients’ signatures on documents authorizing these accounts. Wells Fargo employees called the bank’s practice “sandbagging” and a “sell or die” quota system. More recent reports have surfaced based on sworn statements signed by former Wells Fargo employees that indicate their former bank superiors instructed them to target Native Americans, illegal immigrants and college students as they sought to open sham accounts to meet the bank’s onerous sales goals.

Once the scandal hit the media, rather than placing accountability on those at the helm responsible for the corporate culture that fostered the scheme, Wells Fargo fired 5,300 low-level employees for creating the unauthorized accounts. However, that all changed after Wells Fargo agreed to a $185-million settlement in September 2016 with Los Angeles City Attorney Mike Feuer, the Consumer Financial Protection Bureau and the Office of the Comptroller of the Currency, to end investigations into the unauthorized accounts. Feuer had conducted his own investigation and then sued Wells Fargo, saying the bank’s impossible sales quotas had encouraged “unfair, unlawful, and fraudulent conduct” by employees forced to meet them. Notably, the bank did not admit any wrongdoing as part of the settlement, but apologized to customers and announced steps to change its sales practices. The $185 million settlement consisted of $100 million to the Consumer Financial Protection Bureau—the largest fine the federal agency has ever imposed—as well as $50 million to the city and county of Los Angeles and $35 million to the Office of the Comptroller of the Currency.

Also in September 2016, Wells Fargo CEO John Stumpf appeared before the Senate Banking Committee, where he was grilled by Senator Elizabeth Warren of Massachusetts. Berating Stumpf and noting the shocking lack of accountability, Senator Warren stated: “So, you haven’t resigned, you haven’t returned a single nickel of your personal earnings, you haven’t fired a single senior executive. Instead, evidently, your definition of accountable is to push the blame to your low-level employees who don’t have the money for a fancy PR firm to defend themselves. It’s gutless leadership.” In March 2017, Wells Fargo reached a $110 million preliminary settlement to compensate all customers who claim the scandal-ridden bank opened fake accounts and other products in their name.

Moreover, the independent directors on Wells Fargo’s board created an Oversight Committee to investigate the improper sales practices and to make recommendations to the independent directors. The investigation, assisted by outside counsel Sherman & Sterling, resulted in a detailed 110-page report that the bank released on April 10, 2017. The report laid the blame squarely on the shoulders of former CEO Stumpf and former head of the bank’s community banking business, Carrier Tolstedt— both of whom resigned in the fall of 2016 shortly after the Senate Banking Committee session. As a result of the report, the Wells Fargo Board was determined to clawback approximately $75 million in compensation from the two executives, which is in addition to the $60 million in unvested equity awards Stumpf and Tolstedt agreed to forfeit at the time of their ouster. The claw backs are reportedly the largest in banking history and one of the biggest ever in corporate America. They’re also unprecedented in that they are not called for by either Sarbanes -Oxley or the Dodd-Frank Act, both of which provide for claw backs only in the event of a restatement of financial results. The board also required the forfeiture or clawback of an additional $47.5 million in compensation from other former bank executives, bringing the total amount of compensation that the board has reclaimed to $182.8 million. This is apparently the second-largest clawback of executive compensation in history; and its massive size underscores how high executive compensation was at this bank. The bank also assured the public it has ended its sales quota program.

However, even though repercussions have appropriately made their way to the executive suite, many say it’s not enough. Specifically, angry shareholders claim that the board itself needs to be held responsible for what happened here. Indeed, in April 2017, Institutional Shareholder Services, which advises big investment firms about corporate governance issues, recommended that Wells Fargo’s shareholders oppose the re-election of 12 of the bank’s 15 board members at the bank’s annual meeting. Ultimately, all the board members were re-elected, but some by very small margins, even though they were running unopposed. Shareholders also asked why KPMG, Wells Fargo’s auditor, didn’t discover the phony accounts. Senator Warren and Senator Edward Markey agreed, and called upon the Public Company Accounting Oversight Board, which sets standards for audits of public companies, to review KPMG’s work for Wells Fargo.

Ninth Circuit Extends Whistleblower Protections To Employees Who Report Fraud to Management


Corporate employee-informants play an essential role in the enforcement of the federal securities laws. By reporting wrongdoing that might otherwise be very difficult for outside investors to detect, informants can make it easier to investigate and correct ongoing frauds, limiting the harm inflicted on investors as well as the broader public. In fact, according to a 2008 study by the Association of Certified Fraud Examiners, frauds are more likely to come to light through whistleblower tips than through internal controls, internal or external audits, or any other means.

Because confidential informants play such a vital role in disclosing and deterring securities fraud, the law recognizes the importance of protecting them from retaliation. The Sarbanes-Oxley Act of 2002 (“SOX”) requires companies to create robust internal compliance systems through which employees can anonymously report misconduct, and it protects such employees from any adverse employment consequences that might result. Significantly, SOX requires that certain employees first report violations internally, to allow the company to take corrective action before the SEC gets involved. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 further expands informants’ incentives by directing the SEC to pay a bounty to any “whistleblowers” who provide the SEC with information leading to a successful enforcement action.

Dodd-Frank includes an anti-retaliation provision that prohibits employers from retaliating against a “whistleblower” for acting lawfully within three categories of protected activity: (1) providing information to the SEC, (2) assisting in any SEC investigation or action related to such information, or (3) “making disclosures that are required or protected  under” SOX or any securities law, rule, or regulation.

In recent years, some corporate defendants have argued that Dodd-Frank’s anti-retaliation provision does not protect employees who complain internally about wrongdoing if they do not report to the SEC before they suffer retaliation. They argue that the provision’s text only protects a “whistleblower,” which Dodd-Frank elsewhere defines as an individual “who provides information relating to a violation of the securities laws to the Commission.” So, if an employee reports a suspected violation to a supervisor or internal compliance officer and is then fired before he can report to the SEC, he is not a “whistleblower” as defined under Dodd-Frank’s anti-retaliation provision.

In March 2017, the Ninth Circuit rejected this argument in Somers v. Digital Realty Trust. The plaintiff had complained to senior management about “serious misconduct” by his supervisor, but was fired before he could report to the SEC. The district court denied the company’s motion to dismiss, holding that, because the plaintiff was fired for internally reporting a suspected violation—in other words, for “making disclosures that are required or protected under” SOX—he was protected under Dodd-Frank’s anti-retaliation provision.

The Ninth Circuit affirmed, holding that Dodd-Frank’s anti-retaliation provision “necessarily bars retaliation against an employee of a public company who reports violations to the boss.” In reaching its conclusion, the Ninth Circuit emphasized “the background of twenty-first century statutes to curb securities abuses,” noting that SOX did not just strongly encourage internal reporting; it prohibited certain employees, such as lawyers, from reporting to the SEC until they’d first reported internally. Dodd-Frank’s antiretaliation provision “would be narrowed to the point of absurdity” unless it protected employees who reported internally; otherwise, the law would require lawyers to report internally and then “do nothing to protect these employees from immediate retaliation in response to their initial internal report.” The Ninth Circuit thus agreed with the Second Circuit, which had reached the same conclusion in 2015 in Berman v. Neo@Ogilvy LLC.

Dodd-Frank’s promise of robust anti-retaliation protection is critical to deterring and correcting corporate fraud. By protecting whistleblowers whether they speak up internally or to law enforcement, the Ninth Circuit has helped ensure that both the external securities regulation system and the internal compliance system within each company can make use of these whistleblowers’ knowledge and insights in combating corporate fraud—and that wrongdoers cannot avoid the whistleblower protections entirely by firing any employee who reports misconduct internally, before he or she has the chance to inform the SEC.

Gorsuch Appointment Takes Partisanship To A New Level

ATTORNEYS: H. Adam Prussin and Jessica N. Dell

Quick quiz: who wrote this?

the politicization of the judiciary undermines the only real asset it has — its independence. Judges come to be seen as politicians and their confirmations become just another avenue of political warfare. Respect for the role of judges and the legitimacy of the judiciary branch as a whole diminishes. The judiciary’s diminishing claim to neutrality and independence is exemplified by a recent, historic shift in the Senate’s confirmation process. Where trial-court and appeals-court nominees were once routinely confirmed on voice vote, they are now routinely subjected to ideological litmus tests, filibusters, and vicious interest-group attacks.

Our readers may be surprised to learn that the answer is none other than Neil Gorsuch, President Trump’s appointee to the Supreme Court. After this article appeared in 2005, he was appointed to the Tenth Circuit Court of Appeals and, a few weeks ago, was confirmed to fill the Supreme Court vacancy created by Justice Scalia’s passing in February 2016.

What better example of confirmation through “political warfare” could there possibly have been? Republicans had scuttled President Obama’s nomination of MerrickGarland, refusing to grant Judge Garland evena hearing in the Senate, in the hope that a Republican would win the presidency a year later and appoint a more conservative justice. Once Trump was elected, his new administration immediately began the push for Judge Gorsuch’s confirmation, to restore a 5-4 majority on the court for Republican appointees. When Senate Republican leaders couldn’t rally the requisite 60votes to confirm him, they changed the rules to allow Gorsuch (and all future nominees) confirmation by a simple majority. And a simple majority was all that he got, as both parties voted almost strictly along party lines to deliver the most politicallypolarized judicial confirmation in history.

Ironically, Gorsuch’s 2005 article put all the blame on liberals for the politicization of the Supreme Court. It was they, he said, who supposedly relied too heavily on unelected judges to advance their policy objectives. The passing of time, however, hasshown that Republicans can play that game at least as well as Democrats. Garland’s totally partisan rebuff, followed by Gorsuch’s totally partisan confirmation, come on the heels of a series of conservative crusades in the courts including, most notably, their efforts to allow corporate cash to flow unfettered into elections, and multiple attempts to strike down or cripple the Affordable Care Act, and to create a whole new free-fire zone of unlimited gun rights.

Although Gorsuch’s appointment raises a host of concerns, those of us who represent investor rights are especially troubled. In 2005, when he was a member of the Bush Justice Department, he wrote another article, which appeared in Andrews Securities Litigation, where he made plain his hostility to shareholder class actions. The first section of his article is entitled “The Incentive To Bring and the Pressure To Settle Meritless Suits”; the second is headed “The Incentive To Reward Class Counsel but Not Necessarily Class Members”; followed by a series of suggestions for choking off these “meritless” securities cases, most of which come from (or found their way into) the standard defense bar playbook. Prominent among them are his proposals for tightening “loss causation” pleading requirements and for slashing fees awarded to counsel for shareholders. Justice Gorsuch is not going to be a friend to investors. Sadly, the first case he heard after joining the Court was a securities case brought by CALPers.

There are other grounds for concern about Justice Gorsuch’s legal views. Some of them include his belief that corporations are people entitled to constitutional protections, including the rights to buy elections, avoid government regulation and oversight, and to impose management’s religious convictions on their employees. His views prompted Emily Bazelon of the New York Times to write that “Gorsuch embraces a judicial philosophy that would do nothing less than undermine the structure of modern government — including the rules that keep our water clean, regulate the financial markets andprotect workers and consumers.”

As a judge, Gorsuch’s most notable decision might have been his joinder in most of the Tenth Circuit’s en banc ruling in Hobby Lobby Stores, Inc. v. Sebelius, which famously held that the religious beliefs of the owners of a closely held corporation could be imputed to the company and justify its refusal to comply with the law. At issue were the religious beliefs of David Green, the evangelical Christian CEO of the chain. Green claimed that Hobby Lobby was exempt from providing coverage for the full range of contraceptives for his employees under the Affordable Care Act because of his own religious convictions. Gorsuch agreed that those religious beliefs could be considered to be the beliefs of his corporation, and that the Religious Freedom Restoration Act, which protects the religious freedom of all “persons,” therefore applied. Confronted on the topic of Hobby Lobby after his nomination, and asked how he could read the Religious Freedom Restoration Act to include corporations, Gorsuch said he relied on existing case law that support the idea that corporations could be considered as having the same rights as individuals. “Congress could change that if it thinks otherwise,” Gorsuch said. “… and it was affirmed by the Supreme Court.” The Hobby Lobby decision was indeed upheld by the Supreme Court.

If you are a fan of the rights of corporations to impose their will on individuals, while being immune from the claims of their own shareholders, then you will love Justice Gorsuch.

The Supreme Court To Review Duty To Disclose

Attorney: Brenda Szydlo
Pomerantz Monitor May/June 2017

The Supreme Court recently granted certiorari in Leidos, Inc. v. Indiana Public Retirement System, taking up the question whether the Second Circuit erred in holding that Item 303 of SEC Regulation S-K, which imposes specific disclosure requirements on public companies, creates a duty to disclose that is actionable under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. The high court’s decision will resolve a split between the Second and Ninth Circuits, and could expand the playing field to other circuits by giving investors a powerful tool – the ability to use an SEC disclosure regulation as the basis for a securities fraud claim.

The Second Circuit’s decision in Leidos revived a Section 10(b) suit by investors against a government contractor that failed to disclose in its March 2011 Form 10-K a kickback scheme’s impact as a known trend or uncertainty reasonably expected to have a material impact on the corporation’s financial condition in violation of Item 303. The court stated that in Stratte-McClure v. Morgan Stanley, “we held that Item 303 imposes an ‘affirmative duty to disclose . . . [that] can serve as the basis for a securities fraud claim under Section 10(b)[,]’” and now “hold that Item 303  requires the registrant to disclose only those trends, events, or uncertainties that it actually knows of when it files the relevant report with the SEC.” The court concluded that the proposed amended complaint supported a strong inference that Leidos actually knew about the fraud before filing the 10-K, and that it could be implicated and required to repay the revenue it generated to the City of New York.

The Second Circuit’s holding in Leidos is in direct conflict with the Ninth Circuit’s decision in In re NVIDIA Corp. Sec. Litig. In finding that “Item 303 does not create a duty to disclose for purposes of Section 10(b) and Rule 10b- 5[,]” the Ninth Circuit relied on the Third Circuit’s opinion in Oran v. Stafford, written by then-Judge Samuel Alito. In Oran, Justice Alito wrote that “a violation of SK-303’s reporting requirements does not automatically give rise to a material omission under Rule 10b-5” and further held that the duty did not arise under the specific facts of the case. (Emphasis added).

The Supreme Court’s decision in Leidos could be potentially explosive. In Matrixx Initiatives, Inc. v. Siracusano, the Supreme Court held that Section 10(b) and Rule 10b-5 do not create an affirmative duty for public companies to disclose material information, except in cases where an omission renders an affirmative statement misleading. As the Supreme Court stated in Basic v. Levinson, “[s]ilence, absent a duty to disclose, is not misleading under Rule 10b-5.” But the Supreme Court’s decision in Leidos could significantly alter the securities fraud landscape, in that public companies could be subjected to securities fraud liability for failing to comply with Item 303’s duty to disclose information about a subject it had been completely silent about.

Regulation S-K, and Item 303 in particular, set forth comprehensive reporting requirements for various SEC filings. If failure to disclose information required by Item 303 can serve as the basis for fraud, and the same is true for other regulations requiring disclosure of specific information, we could be on the verge of a new era in securities fraud litigation.

Private litigants should have the right to assert securities fraud claims against public companies that hide material information in violation of SEC disclosure regulations. There is no question that the failure to disclose immaterial information cannot support liability, even if Item 303 requires that it be disclosed. However, others will contend that the litigation floodgates will be opened if the high court sides with the Second Circuit and expands silence as a basis for securities fraud claims. Given the importance of the outcome, Leidos warrants careful observation.

Judge Rakoff Challenges The Securities Bar


On July 3, 2016, the European Union implemented Market Abuse Regulation (“MAR”), a rulebook that governs, in part, enforcement of insider trading violations. MAR differs sharply from the American approach to insider trading law in that it does not require the government to link the trade to a known breach of fiduciary duty.

In a speech earlier this month to the New York City Bar Association, U.S. District Judge Jed S. Rakoff challenged the securities bar to draft a statute that would provide needed clarity to U.S. courts trying to make sense of the confusing tangle of judge-made insider trading law and
pointed to MAR as a potential model.

Judge Rakoff suggested that most of the headaches created by U.S. insider trading law arise from judgemade requirements, such as that trading on inside information can be a crime only if the tippee knew that the tipper breached a fiduciary duty. Not only that, but that breach must involve betraying confidences of an employer, and also receiving some kind of personal benefit in exchange.

Judge Rakoff knows these difficulties well. He gave his speech three months after the Supreme Court ruled in the insider trading case Salman v. United States. As we reported in the last issue of the Monitor, Salman held that someone who trades on inside information can be found guilty even if the source of the information was a friend or family member of the tippee, and did not receive a financial quid pro quo. Salman affirmed a 2015 ruling that Judge Rakoff had authored while sitting by designation on the Ninth Circuit Court of Appeals. In a further twist, Rakoff’s Ninth Circuit opinion in Salman relied on his reasoning in a 2013 insider trading decision, which the Second Circuit had reversed on appeal in 2014 in U.S. v. Newman. In effect, Judge Rakoff single-handedly created the circuit split that led the Supreme Court to validate his overturned district court ruling.

But Salman resolved just one of a myriad of issues surrounding insider trading: whether a tip to a friend or relative, without a financial quid pro quo, supports a claim of insider trading. As Rakoff noted in his speech, U.S. insider trading law is a judicial creation based on generalized
antifraud provisions of the federal securities laws. There is no statutory definition of what constitutes inside information, or when a tippee violates the law by trading on it. The result has been that decades of often inconsistent judicial decisions have congealed into a common law morass that erodes investor confidence in the U.S. capital markets.

Some of the difficulties of insider trading law are illustrated by the prosecutions brought by Preet Bharara, the former U.S. Attorney for the Southern District of New York. Notably, he secured a conviction in 2011 of Raj Rajaratnam, the founder of hedge fund Galleon
Group. But when Bharara decided to take on Steven A. Cohen, the hedge fund billionaire who founded S.A.C. Capital Advisors (“SAC”), he ran into a wall created by the requirement that a tippee, to be liable, has to be aware that the source of the inside information violated a fiduciary duty by disclosing it. Bharara decided not to go after Cohen.

As recounted in a recent New Yorker article, Bharara’s decision rested in part on the difficulty
in making the necessary evidentiary showing. The government’s best evidence against Cohen
was an email from one of his traders that conveyed inside information. To win, the government
had to convince a jury that Cohen not only read the email—one of a thousand or so he received
every day—but also that he read to the end of the email chain and realized that the trader’s source had breached a fiduciary duty. Even Bharara, not known for timidity, blinked when faced with an opponent with billions to spend on his defense and a burden of proof that becomes more difficult to carry the more remote the tipper is from the tippee. Instead, Bharara settled for convictions of two of Cohen’s top traders and a $1.8 billion penalty paid by Cohen’s company, SAC. Cohen skated. After shuttering SAC, he set up shop under a new company, and went on trading as if nothing had happened.

Just as telling, even the narrow ruling in Salman, which criminalizes trading on uncompensated tips from friends and relatives, is subject to nitpicking. One of the former SAC traders that Bharaha managed to convict, Mathew Martoma, has appealed his conviction to the Second Circuit on the grounds that the friendship by which the information was passed to him was not a “meaningfully close” friendship.

By contrast, under MAR, the EU treats insider trading as a threat to the proper functioning of the capital markets, in that it impedes transparency. Article 7 of MAR defines “inside information” as non-public information which, if revealed, would significantly affect the price of a security. Regarding tippee liability, Article 8 says that it is “insider dealing” where a tippee uses the tip and “knows or ought to know” that the tip is “based upon inside information.” This approach eliminates the fiduciary duty element of U.S. law, which Judge Rakoff has characterized as a “pretty complicated formulation.” Moreover, in cases against top executives like Steven Cohen, who are often several degrees of separation distant from the source of the tip, it increases the prosecutor’s ability to discern whether the law has been violated. While MAR is a new and relatively untested template, it has the potential to create a clear set of guidelines for traders, regulators, prosecutors and courts to follow, and a regime that the
market can trust.

Pomerantz is familiar with the proof issues in SAC, having recently settled a civil suit for insider trading against Cohen and SAC for $135 million, on claims not pursued by the government.

A Bad Choice For Auditor Reviews


Tucked away in the latest Dodd-Frank reform bill is a provision that threatens to roll back crucial
investor protections for nearly a third of public companies. House Financial Services Committee
Chair Jeb Hensarling’s proposal, called CHOICE 2.0, would exempt all companies with market capitalization below $500 million, and all depository institutions with assets below $1 billion, from auditor review of internal controls. Currently, only the smallest companies – those with market capitalization below $75 million – are exempt from the requirement.

The auditor attestation requirement of Section 404(b) of the Sarbanes-Oxley Act of 2002
serves an important purpose. It helps to identify deficiencies in internal controls over financial
reporting, so that companies can fix those deficiencies at an early stage. Expanding the Section 404(b) exemption to $500 million would increase the number of exempt companies approximately eight-fold. The proposed expansion would also exempt some constituents of common market indices like the Russell 2000 and Russell 3000 from auditor review of financial controls.

While all companies that have been public for more than one year are required to have management attest to the sufficiency of internal controls, repeated academic studies show that the auditor review under Section 404(b) is far more effective. The studies demonstrate
that companies exempt from auditor attestation have a higher rate of accounting irregularities and restatements than those subject to the Section 404(b) requirement. Moreover, a review by the Government Accounting Office, required under Dodd-Frank, determined that compliance with Section 404(b) has a positive impact on investor confidence in the quality of financial reports. A recent analysis from MarketWatch’s Francine McKenna shows that the concern is more than academic. It found that approximately 11.4% of the non-bank companies that received an auditor internal control over financial reporting opinion in 2015 but would be exempted by Hensarling’s bill reported ineffective internal controls. 8.6% of the banks that would be exempted had control deficiencies. If CHOICE 2.0 is implemented, 
investors would not learn of these problems until it was too late.

The measure’s proponents incorrectly claim that removing the requirement will increase initial public offerings of small and mid-market companies. This is a red herring. Newly-public companies are not subject to the requirements of Section 404(b). Regardless of market
capitalization, no company needs to provide a Section 404(b) auditor attestation at the time it goes public, or even with its first annual report as a public company on SEC Form 10-K. The auditor attestation is only required after a company has already filed a full years’ worth of
periodic reports as a public company. Moreover, as an SEC study has determined, the cost to comply with Section 404(b) has declined significantly.

Nor does the broader regulatory environment justify stripping this important investor protection. Scores of recent measures such as the JOBS Act and Regulation A+ have already slashed red tape for small and middle market companies seeking to tap public markets. 
Companies choosing to remain private do so largely because they can easily raise money from private equity firms and lenders, not because current regulatory burdens are excessive.

When a proposal was introduced in 2014 to expand the Section 404(b) exemption to only $250 million, the Center for Audit Quality and the Council for Institutional Investors warned in a joint letter to the House Financial Services Committee that the assurance provided under
that statute was “an important driver of confidence in the integrity of financial reporting and in the fairness of our capital markets.” The expansion proposed today is twice as large, and would cause an even greater threat to investor confidence and accounting integrity.


Class Action “Reform” In The Age Of Trump


In February 2017, Rep. Goodlatte (R-Va.), Chairman of the House Judiciary Committee, introduced the Fairness in Class Action Litigation Act (H.R. 985), a bill that, if passed as written, would make it more difficult for plaintiffs to pursue class action litigation. Rep. Goodlatte was an author of the Class Action Fairness Act of 2005, which limited the ability to bring class actions in state courts. With Republicans now controlling both chambers of Congress and the White House, H.R. 985 stands a very real chance of becoming law. While the ultimate impact on securities class actions is unclear, as written the bill presents a near existential threat to the class action in its current form.

In a press release announcing the bill, Rep. Goodlatte made clear his disdain for class action litigation. “The current state of class action litigation has become an expensive business, and one easily gamed by trial lawyers to their own advantages.” He went on to describe the bill’s goal as “to maximize recoveries by deserving victims, and weed out unmeritorious claims that would otherwise siphon resources away from innocent parties.” According to Rep. Goodlatte, H.R. 985 “will keep baseless class action suits away from innocent parties, while still keeping the doors to justice open for parties with real and legitimate claims, and maximizing their recoveries.” Touting his experience authoring the Class Action Fairness Act of 2005, Rep. Goodlatte highlighted several provisions of the bill purportedly designed to close attorney-exploited loopholes and advance “fairness” for both “deserving victims” and “innocent parties”: preventing class actions filed by attorneys who are relatives of parties in the litigation; requiring that plaintiffs’ attorneys may only be paid after class members have been paid; and requiring disclosure to the court of any third-party litigation funding agreements.

Yet key features of H.R. 985 have nothing to do with weeding out frivolous claims or protecting “innocent parties.” Rather, the bill, as designed, would make it more difficult to prosecute any claims in class actions. For example, the bill prohibits federal judges from certifying a class unless “each proposed class member suffered the same type and scope of injury as the named class representative or representatives.” Limiting the range of injuries to be adjudicated in a single action naturally reduces the number of claims that can be aggregated.

Perhaps of the greatest significance for securities class actions, however, is a subsection titled “Prohibition of Conflicts,” which precludes federal judges from certifying a class for which the lead plaintiff is “a present or former client of . . . or has any contractual relationship with” class counsel. This provision would make it significantly more difficult to bring claims, either as a plaintiff or class counsel. In particular, this provision would prevent institutional plaintiffs from selecting the same firm as lead counsel in multiple litigations. The broad language of the bill, which precludes a lead plaintiff from retaining a firm it has “any contractual relationship with” whatsoever, would even prevent an investor from selecting as lead counsel a firm that
had previously merely provided portfolio monitoring services to the investor. 

As Professor John Coffee, an eminent commentator on securities law, stated in his recent article critiquing this bill, “the standard pattern in securities class actions” is for a “public pension fund [to] act as a lead plaintiff and retains a major plaintiff’s law firm that it has used before (presumably because it was satisfied with its prior efforts) …. Because the client may not use a firm that it has ever previously retained (apparently for any purpose), the result is to impose a legal regime of “one night stands” on clients and their counsel. Who benefits from this? The only plausible answer is: defendants!” Professor Coffee also notes that the provision may be unconstitutional because “several Circuits have repeatedly held that the Due Process Clause guarantees not simply the client’s right to retain counsel in a civil case, but “the right to choose the lawyer who will provide that representation.” Similarly, legal blogger Alison Frankel observed that “[s]ophisticated plaintiffs in complex securities and antitrust litigation need specialized lawyers, just like defendants in the same cases. … Why should a corporation be allowed to have an ongoing relationship with outside counsel but not a pension fund acting as a lead plaintiff?”

Interfering with an institution’s choice of counsel has nothing to do with weeding out frivolous claims or protecting the innocent. It is simply intended to discourage any financial institution from acting as a class representative. Notably, existing law (The Private Securities Litigation Reform Act of 1995 (the “PSLRA”)) already prohibits any institution from serving as a lead plaintiff in more than five securities class actions over a three year period.

The effect of this provision stands in marked contrast to the stated goal of the PSLRA, which was to encourage institutional investors to assume a greater role in securities class actions. In part, the rationale underlying this goal was that institutional investors, compared to “retail” investors, are sufficiently sophisticated to take an informed and active role in the litigation process, thus ensuring that the interests of the plaintiff remain front and center, while minimizing concerns about attorney-driven litigation. This new bill, for its part, purports to protect plaintiffs from unscrupulous attorneys who would take advantage of them, but actively denies institutional investors the option of working with attorneys with whom they have an existing relationship, practically ensuring that the most sophisticated plaintiffs assume a diminished role in class actions. 

H.R. 985 would also provide a host of other procedural obstacles to the prosecutions of class actions, whether or not those actions are meritorious. As Professor Coffee notes, the bill “would also slow the pace of class actions to a crawl. [because it] permits appeals of orders granting or denying class certification as a matter of right. Today, such interlocutory appeals are discretionary with the appellate court (and are infrequently granted). … Second, discovery is halted if defendant makes any of a variety of motions ….Predictably, such motions will be made one after another, in seriation fashion, to delay discovery.” 

At present, the full scope and application of H.R. 985 remains unclear. A recent Wall Street Journal article reported that Lisa Rickard, president of the Institute for Legal Reform of the U.S. Chamber of Commerce, a major backer of the bill, has indicated that the bill is not intended “to restrict securities class actions . . . and will likely be clarified as it moves forward through the House and Senate.” Nonetheless, as drafted, nothing in H.R. 985 limits the scope of its provisions to exclude securities class actions, and Ms. Rickard has previously characterized securities class actions as “betraying the individual investors [they are] designed to assist.” Several amendments proposed by Democrats that would have provided carve-outs for certain types of class actions were voted down in committee.

All of this, of course, presupposes that the legislation ultimately passes both the House and Senate and is signed into law—and even with Republican majorities in both chambers, this is not a foregone conclusion. At the time of this writing, H.R. 985 had narrowly passed through the House by a margin of 220-201, with all Democrats and 15 Republicans voting against it. Legitimate doubts exist as to whether the Senate Judiciary Committee, despite being controlled by Republicans, would let the bill out of committee without some measure of bipartisan support.


Recovery Of Reputational Damages In Securities Fraud Cases


To paraphrase Tolstoy, while all good companies may be alike, all frauds are not. Corporate frauds usually involve lies about financial information, such as historic results or future prospects. The financial impact of these frauds on the company’s stock price is foreseeable and easily measured. However, the effects of lies that reflect the lack of management integrity or ineffectiveness of corporate governance controls are arguably less readily measured. These lies often have only a small direct impact on the bottom line; but when the truth is revealed, the effect on the company’s stock price can be substantial. Such stock price effects, sometimes referred to as “reputational losses” or “collateral damage,” are attributable to the market’s  reassessment of investor risks, including possible management turnover, or the possibility that problems lieahead. Nonetheless, the ability to recover the damages in these instances is disputed by some corporations and academics.

A textbook example of reputational losses is what happened at Wells Fargo. At the beginning of September 2016, the bank had surpassed its rivals to become the largest financial institution measured by stock market capitalization, with assets exceeding $100 billion. It had distinguished itself from peers through its “cross-selling” policy, i.e., marketing a menu of products (such as savings accounts and insurances policies) to checking account customers. Wells Fargo touted its cross-selling successes in shareholder reports, which were closely followed by analysts.

However, on September 8, 2016, investors were shocked to learn that the bank had agreed to pay $190 million to regulators to settle claims arising out of abusive cross-selling practices. Senior management’s pressure to meet astronomical cross selling “goals” – which was actually a euphemism for quotas – had pushed branch bank officers to engage in abusive and illegal practices in order to meet those quotas. Without informing their customers, much less obtaining their consent, bank officers withdrew funds from customers’ checking accounts near the end of the quarter, placed the funds in a new savings account for the customers, and then reversed the transactions at the beginning of the next quarter. Such schemes allowed bank officers to meet their quotas, while customers often found themselves paying overdraft fees when their checks unexpectedly bounced.

Senior Wells Fargo officials were aware of the illegal practices, having fired over 5,000 bank employees over several years for doing this. However, management continued to pressure bankers to meet cross-selling quotas, and awarded multi-million dollar bonuses to the Executive Vice President responsible for implementing the practices, making further illegal acts by many employees inevitable.  

These illegal practices had virtually no effect at all on Wells Fargo’s bottom line. They resulted in only $2 million of additional revenues for the bank over a multi-year period, and even the $190 million regulatory settlement was like a drop in the bucket to such a giant company. Most telling, none of the financial data or cross-selling metrics were materially false. Nonetheless, concern about the adverse publicity, potential investigations and management shake-up caused Wells Fargo’s share price to tumble 6% within days of the September 8, 2016 disclosure. Declines continued as pressure mounted for the resignation of the bank’s CEO, John Stumpf. By the time Stumpf appeared to testify before a Congressional panel, Wells Fargo shares had fallen 16% -- although Wells Fargo’s financial condition and prospects had not significantly changed.

Another example of pure reputational losses arose last year with Lending Club, a leader of the newly minted “online” lending services. LendingClub focuses on sub-prime customers whose credit ratings are too low to qualify for loans from regular banks. Once the loans were made, Lending Club bundled them and sold them to funders.

On May 9, 2016, Lending Club’s CEO, Renaud Laplanche, was forced to resign following findings by an internal investigation that $22 million in loans had been improperly sold to the Jeffries Group (one of its funders), in contravention to Jeffries’ express instruction. There were also indications that Laplanche had undisclosed interests in one of the company’s potential funders. The size of the improperly sold loans paled in comparison to the billions that Lending Club lent over the last several years.

Again, nothing indicated that Lending Club’s historic performance had been inflated, nor that its operating model was flawed. However, once these infractions were disclosed, investors immediately drove the stock price down 30%.

Reputational Losses Are the Rule, Not the Exception.

They occur whenever financial missteps are disclosed, whether the effects on the bottom line are material or not. Studies have shown that when a company restates prior performance or future prospects, only a portion of the declines in stock price can be explained by the resulting recalibration of likely future cash flows, a primary factor in stock valuation. Significant, if not larger, portions of those declines arise from the market’s reassessment of management’s reliability or integrity. One study actually concluded that “[f]or each dollar that a firm misleadingly inflates its market value, on average, it loses this dollar when its misconduct is revealed, plus an additional $2.71, due to reputation loss.”

Market perceptions of managerial competence and integrity are a distinct and critical factor in determining the stock price. Disclosure of fraud, as it reflects a lack of corporate integrity, augments any stock price reaction triggered by revising reported results. When the reliability and credibility of statements issued by management is called into question, it increases the perceived information asymmetry between management and stockholders.

The SEC has embraced the view that management integrity is critical to shareholder valuation: “[t]he tone set by top management––the corporate environment or culture within which financial reporting occurs––is the most significant factor contributing to the integrity of the financial reporting process.” So too has the Public Company Accounting Oversight Board. Courts have also recognized the impact of management integrity on stock valuations, deciding that investors may base their investment decisions, at least in part, on factors such as management ethics and accountability.

Perhaps because these effects are undeniable and substantial, defendants in securities fraud actions increasingly argue that stock declines caused by revelations of integrity issues are not recoverable. The case for denying such recovery was made forcefully in a law review article by Cornell and Rutten in 2009, entitled Collateral Damage and Securities Litigation (“Cornell/Rutten”). The authors defined collateral damage as “the valuation impact of a corrective disclosure that does not correspond to the original inflation.” They explained that, if the original misconduct did not materially affect the company’s bottom line, it could not have inflated the company’s market price at the time of purchase; therefore, “because the original misstatement could not have inflated the stock price in an efficient market, the decline following the corrective disclosure must be due to collateral damage.” They concluded that “while collateral damage can have a material impact on securities prices, declines associated with collateral damage are not, and should not be, recoverable under section 10(b) of the Securities Exchange Act of 1934.”

Presumably this analysis could apply even when the underlying misconduct did have a material effect on the company’s bottom line, but the post-disclosure price drop is viewed as “disproportionate” to the specific financial impact of the fraud. Experts would then be called upon to parse out how much of the post-disclosure price drop was “proportional” and how much represents “collateral damage” caused by the realization that management was incompetent or corrupt.

It is true that, in assessing “loss causation,” a fundamental element of any securities fraud claim, courts have started with the precept that the underlying fraud must have inflated the purchase price of the stock, and that revelation of the fraud removed that inflation, injuring investors. Cornell/ Rutten’s fundamental assumption is that stock price inflation can be caused only by misstatements of financial information, such as revenue or cash flows. They fail to attribute any possible inflation to investors’ mistaken assumption of management integrity, and thus the reliability of statements regarding performance and outlook. But perceptions of competence and integrity are as critical as profits and losses in determining and maintaining the market price of a company’s stock. That is why, when such perceptions are shaken, the market price drops dramatically.

Public policy objectives also support recovery of such reputational losses. As noted by the Second Circuit in Gould v. Winstar Communs, Inc.:

 The argument is one of culpability and foreseeability. When a defendant violates section 10(b) by making a false statement to investors with scienter, the defendant in many cases should be able to foresee that when the falsity is revealed, collateral damage may result. As between the culpable defendant—who could foresee that investors would suffer the collateral damage—and the innocent investors, it would seem entirely appropriate to require the defendant to be the one to bear that loss.

 Thus, when a company makes affirmative misrepresentations concerning its managerial competence and integrity, there can be no doubt that those statements help inflate the market price of its stock. But it is just as true that, in the absence of any representations on this subject, investors should be entitled to assume that management has the basic integrity necessary to guiding a modern public corporation. Just as it is reasonable to recognize that investors are entitled to presume the “integrity of the market” (untainted by fraud), so too should investors be entitled to presume the “integrity of management” (untainted by a propensity to commit fraud). Recovery of such additional “reputational” damages is consistent with policies intended to curb securities fraud.

“Scheme Liability”: When Can Investors Sue Bad But Silent Actors For Securities Fraud?

Attorney: Michele S. Carino
Pomerantz Monitor January/February 2017

In Pomerantz’s precedent-setting Stoneridge case, the Supreme Court recognized that securities fraud can be committed by people who themselves make no public statements, but who nonetheless deploy a “device, scheme, or artifice to defraud” or engage in “any act, practice, or course of conduct” that defrauds a person in connection with the purchase or sale of a security – socalled “scheme liability.” Because deceptive conduct often accompanies or facilitates false statements, it has been difficult to discern what type of conduct, by itself, can satisfy this “scheme liability” standard. In other words, what is actionable fraudulent or deceptive conduct?

On December 28, 2016, in a case called Medtronic, the Eighth Circuit addressed that question. Medtronic involved claims that the company, its officers and senior managers and certain doctors had engaged in a scheme to defraud investors by concealing information related to Medtronic’s product, INFUSE, which was developed as an alternative to bone grafting procedures in spinal surgery. In particular, plaintiffs alleged that Medtronic violated the securities laws, because not only did it fail to disclose financial ties between the company and doctors who conducted the clinical trials for INFUSE, but it also paid doctors to conceal adverse events, employ weaker safety rules for clinical trials, and publish favorable articles promoting the product. Medtronic sought dismissal of the scheme liability claims, arguing that it could not be held liable for the false or misleading statements made by doctors concerning INFUSE, because it was not the “maker” of those statements. The district court agreed, and dismissed the case.

The Eighth Circuit reversed. In the first instance, it distinguished between scheme liability claims, which may be brought by private investors, and “aiding and abetting” claims, which cannot. The court explained that aiding  and abetting refers to situations where “entities … contribute ‘substantial assistance’ to the making of a [false] statement but do not actually make it.” For instance, if a supplier engaged in sham transactions with a company so that the company could boost its revenues and misstate its financials, the supplier cannot be held directly liable for the false statements made by the company. In contrast, scheme liability imposes primary liability “based on conduct beyond misrepresentations or omissions.” Thus, the actor has to actually do something besides knowing that a statement is false. As a result, the Eighth Circuit cautioned that “a plaintiff cannot support a scheme liability claim by simply repackaging a fraudulent misrepresentation as a scheme to defraud.

In Medtronic, the court found that “the act of paying physicians to induce their complicity is the allegation at the heart of the scheme liability claim.” This deceptive con duct was separate and apart from the misrepresentations themselves, and thus, not merely a “repackaging” of allegations to create a scheme.

The Eighth Circuit also reaffirmed that to state a claim based on a deceptive scheme, a plaintiff must allege that the market relied on the fraudulent conduct. Following the Supreme Court’s decision in Stoneridge, the court explained that this “causal connection” between the defendant’s deception and the plaintiffs’ injury was necessary to limit liability to conduct that affected the price of the company’s stock and therefore caused the plaintiff’s loss. Otherwise, scheme liability could be extended to all aiders and abettors whose conduct may have facilitated the fraud, but which did not reach the public. In Stoneridge, the Supreme Court held that the scheme liability claim failed, because investors could not demonstrate that they relied on defendants’ conduct, and thus, the necessary “causal link” was missing. But in Medtronic, the court found that Medtronic’s manipulation of clinical trials and concealment of adverse results directly caused the production of false information on which the market relied. Indeed, the company utilized the fraudulent scheme as a mechanism to convince investors of the company’s competitiveness and sustainability. Because reliance was established, the court upheld the scheme liability claim.

Although potential defendants may characterize the Eighth Circuit’s decision as a “back-door” to circumvent the restrictions on bringing claims against aiders and abettors, it is no such thing. Rather, the Eighth Circuit carefully defined the requirements for bringing a scheme liability claim consistent with the language of the securities laws, as well as the recognition by numerous courts that “conduct itself can be deceptive.” The Eighth Circuit’s decision highlights an important mechanism for investor recovery, because actors can and should be held accountable for their actions, as well as their words, particularly when markets are affected.

It’s Not OK To Leak Inside Information To Your “Trading Relative Or Friend”

Attorney: Jennifer Banner Sobers
Pomerantz Monitor January/February 2017

The past two years have seen a series of significant decisions on insider trading criminal liability, which all came to a head last month when the Supreme Court handed down its decision in Salman v. United States. The Court affirmed the conviction of a person who traded on inside information that he had received from a friend who was also a relative-by-marriage. It held that the recipient of inside information (the “tippee”) could be convicted even if the person who disclosed it (the “tipper”) did not receive any tangible financial benefit in exchange for tipping the information – a tipper is liable if s/he personally benefits by gifting confidential information to a trading relative or friend.

The issue started to percolate two years ago when, as we reported at the time, the Second Circuit issued a controversial decision in U.S. v. Newman. There, the court overturned the insider trading convictions of tippees who were several layers removed from the original tipper. The Second Circuit held, among other things, that in order to convict, the government had to provide evidence of a tangible quid pro quo between tipper and tippee. The court’s reasoning seemed to run afoul of the Supreme Court’s insider trading decision decided decades earlier, Dirks v. SEC, which held that tippee liability hinges on whether the tipper’s disclosure breaches a fiduciary duty, which occurs when the tipper discloses the information for a personal benefit. Further, the personal benefit may be inferred not only where the tipper receives something of value in exchange for the tip, but also if s/he makes a gift of confidential information to a trading relative or friend. The Second Circuit, by contrast, held that the government could not prove the receipt of a personal benefit by the mere fact of such intangible things as a friendship, or that individuals were alumni of the same school or attended the same church. The Supreme Court declined to review the Newman decision.

Less than a year later, the Ninth Circuit weighed in with its decision in U.S. v. Salman, in which it held that the “personal benefit” requirement did not always require that the tipper receive a financial quid pro quo. The court reasoned that the case was governed by Dirks’s holding that a tipper benefits personally by making a gift of confidential information to a trading relative or friend. With the split among the Circuits in place, this time the Supreme Court took up an appeal to settle the Circuit split on the “narrow issue” of whether the government must prove that a tipper received a monetary or financial benefit or whether gifting inside information to a trading relative or friend is enough to establish liability.

The Supreme Court upheld the Ninth Circuit’s analysis. Last month, SCOTUS found that Dirks “easily resolves” the narrow issue presented. It reasoned that under Dirks, when an insider makes a gift of confidential information to a trading relative or friend, the tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient. In these situations, the tipper personally benefits because giving a gift of trading information to a trading relative is the same thing as trading by the tipper followed by a gift of the proceeds – the tipper benefits either way. The Court consequently reasoned that by disclosing information as a gift to his brother with the expectation that he would trade on it, the former Citibank investment banker breached his duty of trust and confidence to Citigroup and its clients – a duty acquired and breached by Salman when he traded on the information with full knowledge that it had been improperly disclosed. Thus, SCOTUS decided that the Ninth Circuit properly applied Dirks to affirm Salman’s conviction.

This decision is in line with the direction most Justices seemed to be heading during oral argument, about which we most recently reported. At that time, SCOTUS seemed reluctant to side with Salman to find that a tipper does not personally benefit unless the tipper’s goal in disclosing information is to obtain money, property, or something of tangible value, which SCOTUS signaled during the argument would conflict with Dirks. Ultimately, the Court made clear in its decision that traders can be liable even if the insider does not receive a financial benefit for passing the tip as long as the insider makes a gift to a trading friend or relative.

In this decision, SCOTUS significantly noted that to the extent the Second Circuit in Newman held that the  tipper con must also receive something of a pecuniary or similarly valuable nature in exchange for a gift to a trading relative, that rule is inconsistent with Dirks. It is hard to believe that anyone could be more pleased about that pronouncement than Preet Bharara, United States Attorney for the Southern District of New York. Since the Newman decision, Bharara’s office has dropped at least a dozen cases against alleged inside traders, including ones who had already pled guilty, largely because of the Second Circuit’s analysis. The day SCOTUS handed down its decision, Bharara issued a press release in which he said “the Court stood up for common sense” and that the “decision is a victory for fair markets and those who believe that the system should not be rigged.”

However, the Supreme Court declined to take its decision to the other extreme that the government proffered – that a gift of confidential information to anyone, not just a trading relative or friend, is enough to prove securities fraud because a tipper personally benefits through any disclosure of confidential trading information for a personal purpose.

Indeed, SCOTUS did not venture any further than the contours of this case – the “gift of confidential information to a trading relative” – that Dirks envisioned. SCOTUS reaffirmed its statement in Dirks that “determining whether an insider personally benefits from a particular disclosure, a question of fact, will not always be easy for courts.” The Court seemed relieved that it did not have to “address those difficult cases” in deciding this case.

So what does this all mean? Well, in the wake of this decision, we will probably see a ramp up of insider trading prosecutions by Bharara’s office and other prosecutors in 2017 against people who passed insider tips to their relatives and friends.

However, the Salman decision did not address the other reasons the Second Circuit reversed the Newman defendants’ convictions, and in many instances, those additional obstacles could prove daunting. The Second Circuit held that the government had to prove not only that the tipper received a personal benefit, but also that defendants knew the information they traded on came from insiders and that the insiders received a personal benefit in exchange for the tips. These issues provide a significant bar for the government to overcome with respect to proving remote tippee liability, where the original tip is passed around from the original tippee to his or her colleagues, and those further down the information chain may know nothing about where the information came from, much less whether the tipper benefited from leaking the information. This is exactly what happened in Newman as Bharara’s office had become renowned for pursuing pre-Newman. Moreover, courts gained no learning from SCOTUS as to where to draw the line regarding how close a friend must be or how far removed a relative can be to trigger insider trading liability. Indeed, the court consistently referenced the precise wording in the Dirks decision, “trading relative,” presumably to avoid elaborating on what that actually means. Given the dearth of Supreme Court insider trading cases, courts may continue to struggle with these issues for years to come.

A Dark Cloud's Silver Lining: The First Circuit's Decision In Ariad Pharmaceuticals

Attorney: Louis C. Ludwig
Pomerantz Monitor: January/February 2017

On December 14, 2012, ARIAD Pharmaceuticals announced that the FDA had approved the marketing of ponatinib, a treatment for advanced-stage chronic myeloid leukemia (“CML”), a unique and especially deadly form of leukemia. Like many cancer-focused drug companies, ARIAD first secured approval for ponatinib to treat only the most gravely ill cancer patients. Ponatinib quickly became ARIAD’s most important drug, the linchpin of its entire business. The FDA’s action was not all good news, however, as it required ARIAD to include a “black box” warning on ponatinib’s label disclosing the risk of possibly deadly side effects, most notably adverse cardiovascular events. Meanwhile, ARIAD conducted further studies to see if the drug was safe and effective enough to use with expanded classes of patients, including those who were not as seriously ill.

Despite the black box warning, ARIAD nevertheless continued to publicly project confidence in ponatinib’s future. But before too long, more troubling news came out. First, on October 9, 2013, ARIAD informed investors that it was pausing enrollment in all clinical studies of ponatinib due to increased instances of medical complications. Days later, ARIAD disclosed that it had agreed to halt an international, open-label trial of ponatinib trial entirely. Finally, on October 31, ARIAD announced that it was “temporarily suspending the marketing and commercial distribution” of ponatinib at the direction of the FDA. The market reacted harshly, and ARIAD’s stock price fell all the way to $2.20 per share.

A shareholder class action lawsuit was not far behind. Even for the tiny group of patients who had been allowed to receive the drug, those who were the most desperately ill, ponatinib was something of a mixed blessing. Ponatinib is targeted at relatively few CML patients because the drug is not safe enough for a broader swath of CML patients. ARIAD has used these restrictions to push through price hikes on a regular basis. By early 2015, ponatinib’s monthly gross price was $11,280. As of October 2016, it had increased to $16,561 for a month’s supply, prompting a public rebuke from Senator Bernie Sanders.

As in all securities fraud class actions, ARIAD moved to dismiss the case. The district court granted the motion, but on November 28, the First Circuit held that one of plaintiffs’ alleged misrepresentations did raise a compelling inference that ARIAD’s executives acted with scienter, or intent to defraud. That statement occurred at a breakfast meeting with securities analysts, where ARIAD executives allegedly said that the company expected the drug to be approved by the FDA with a “favorable label.” That statement was then included in an investment bank’s report that was disseminated to the market the following day. The truth, however, was that the FDA had already informed the company that it was rejecting Ariad’s proposed label and requiring additional safety disclosures.

The misstatement that the appellate court held to be actionable is significant because it related to defendants’ representations to investors that failed to disclose critical communications with the FDA. That statement was deemed both material and strongly supported an inference of scienter. The court held that ARIAD’s upbeat comments at the meeting amounted to an “expression of . . . hope without disclosure of recent troubling developments [that] created an impermissible risk of misleading investors” and was therefore knowingly or recklessly misleading. This claim will move forward in the district court.

This is notable because the First Circuit has ratcheted up the already-stringent pleading standards in securities class actions for both materiality and scienter. Its 2015 decision in Fire and Police Pension Ass’n v. Abiomed, Inc. held that doubts about the materiality – or significance to investors – of a statement can prove fatal to a plaintiff’s scienter allegations.

In In re: ARIAD Pharmaceuticals Inc. Securities Litigation, an appellate panel that included retired Supreme Court Justice David H. Souter recognized that misleading statements that omit information about communications with the FDA can support a finding of scienter. Such communications are frequently at the heart of securities class actions involving pharmaceutical companies.

ARIAD Pharmaceuticals is in line with long-standing circuit precedent that statements published in light of a defendant’s knowledge of contrary facts provide classic evidence of scienter. What is new is that the Court of Appeals has joined lower courts within the First Circuit in explicitly extending this principle to the realm of FDA communications so often kept secret until the truth is revealed to investors. Therefore, despite largely affirming the lower court, ARIAD Pharmaceuticals will nonetheless help plaintiffs who allege misrepresentations of FDA communications meet the tough pleading standard set by the First Circuit in Abiomed.

Supremes Take Up Three Big Cases

Attorney: H. Adam Prussin
Pomerantz Monitor January/February 2017

The Supreme Court has recently granted certiorari in three cases of great interest to the business world.

Class action waivers in employment agreements. One case, Murphy Oil, concerns the question of whether employees can be forced, as a condition of their employment, to sign agreements that prevent them from joining together to bring class actions in court against their employers. In this case, employees claim that they were forced to sign agreements containing arbitration provisions that prohibit them from pursuing class or collective actions, in violation of the National Labor Relations Act (the “NLRA”). In the wake of the Supreme Court’s 2011 decision in AT&T Mobility, which upheld class action waivers in some consumer transactions, corporations have increasingly turned to this device to try to slam the courthouse door on people attempting to sue them. The availability of class actions is often the only economically feasible way for people with small claims, or small resources, to pursue their rights.

Wells Fargo is also trying to enforce agreements precluding class actions brought by its own customers who claim that Wells Fargo opened accounts in their names without permission.

The class action waiver debate turns on the fact that these provisions are included in arbitration agreements.

The Supreme Court likes to enforce arbitration agreements, which it considers to be an efficient, costeffective alternative to full blown judicial proceedings. Arbitrations are typically not considered suitable for conducting class action procedures because these procedures undermine the efficiency and costeffectiveness of arbitration. But wiping out the right to participate in class actions, just to promote the use of arbitration, would effectively deprive claimants of any effective remedy at all. That’s because the alternative to judicial class actions is not a host of individual arbitrations, which could never be cost-effective for the claimants, but no claims being filed at all.

The NLRA says that “[e]mployees shall have the right to “engage in other concerted activities for the purpose of collective bargaining or other mutual aid or protection.” The Supreme Court has described these provisions as including employees’ efforts “to improve terms and conditions of employment or otherwise improve their lot as employees through channels outside the immediate employee employer relationship,” including “through resort to administrative and judicial forums.” The National Labor Relations Board, which rules on these matters in the first instance, considers the “no class action” provisions to be illegal, in violation of the NLRA, because they interfere with efforts of employees to pursue their rights collectively. Because these provisions are illegal they are not enforceable under the Federal Arbitration Act, which governs the use of arbitration provisions.

In AT&T Mobility, the Supreme Court held that state laws providing that that class action waiver provisions are unenforceable because they are unconscionable (i.e. grossly unfair and one-sided) do not make the class action waiver provisions  illegal. In Murphy Oil, the Fifth Circuit held that the NLRA does not “override” the FAA and that the “use of class action procedures . . . is not a substantive right.”

The two places where waiver provisions are most common are employment and consumer transactions. The Court’s resolution of Murphy Oil, and its companion cases, will decide the fate of such provisions in one of its two most common applications.

Tolling Statutes of “Repose.” Key provisions of the securities laws tend to have two different periods of limitations, within which actions must be brought or be time-barred. The first, and most familiar, is the statute of limitations, which typically expires a certain amount of time after the cause of action “accrues.” Because accrual typically depends on whether plaintiffs knew or should have known about the facts constituting their claim, statutes of limitation tend to be elastic, with no readily knowable expiration date. To mitigate this uncertainty, the statute of repose tends to expire a certain amount of time after the transaction occurs that is the subject of the lawsuit. This provides potential defendants with a definitive date when they are “in the clear.” For the antifraud provisions of the Securities Exchange Act, including Section 10(b), claims are barred two years after the plaintiff knew or should have known about the facts constituting the violation (statute of limitations) or five years after the violation itself (the statute of repose). Claims under Sections 11 or 12 of the Securities Act must be brought within the shorter of one year from the date of the violation (statute of limitations), or three years from the date the security was first offered to the public and in no event more than three years after the relevant sale (statute of repose).

What happens if, shortly after an alleged violation comes to light, an investor files a class action raising claims under the securities laws? Does every member of the class have to file his own case within the limitations/repose periods to prevent the statutory periods from running out on them? In American Pipe, the Supreme Court decided in 1974 that the filing of a class action “tolls” the statute of limitations for all class members; so that if, many years down the road, the court decides not to certify the class, or some class members are dissatisfied with a proposed settlement, members of that would-be class could still file their own actions.

But then, almost 40 years later, companies started wondering whether American Pipe tolling also stopped statutes of repose from running. And in 2013, in Indymac, the Second Circuit said that it didn’t. Although the Supreme Court granted cert in that case, the parties settled before the Court could decide it. The issue has now come up again in a case brought by CalPERS under the Securities Act against ANZ Securities and other underwriters of mortgage-related securities issued by Lehman Brothers.

Lehman Brothers issued over $31 billion of debt securities between July 2007 and January 2008. CalPERS purchased millions of dollars of these securities. On June 18, 2008, another investor filed a securities class action lawsuit in the Southern District of New York against Lehman Brothers and certain of its directors and officers, alleging that the defendants had made material misrepresentations and omissions with respect to the debt offerings. In February 2011, more than three years after the debt offerings, CalPERS filed its own, separate complaint under the Securities Act, also challenging alleged misrepresentations and omissions in the offering documents. Later in 2011, the securities class action lawsuit settled, and CalPERS opted out of the settlement in order to pursue its own claims. CalPERS argued that its own individual claim would not be barred by the three-year statute of repose for its Securities Act claims because that three-year period was tolled during the pendency of class actions involving those securities.

The pros and cons of this question are all quite technical, but boil down to the question of whether the equitable tolling doctrine derives from the class action procedural rules, or, rather, is based on judicially created doctrines intended to promote fairness. Appellate courts have come down on both sides of this issue. Although the issue is technical, the consequences of a ruling, either way, will be seismic.

As noted in the D&O Diary, a prominent securities industry publication, without the benefit of American Pipe tolling with regard to the statute of repose, many investors, including institutional investors, will have to monitor the many cases in which their interests are involved more closely, and intervene or file individual actions earlier in order to preserve their interests. It its cert petition, CalPERS argued that in the circuits’ holding that the prior filing of a securities class action lawsuit,

potential securities plaintiffs are forced to guess whether they must file their own protective lawsuits to safeguard against the possibility that class certification in a pending action will be denied (or granted, then overruled on appeal) after the limitations period has run. If they guess wrong, genuine injuries and blatant frauds may go unaddressed. If they act conservatively, they will burden the courts with duplicative pleadings and redundant briefing that serve no real-world purpose.

By the time a class action reaches the settlement stage, and class members have to decide whether to opt out or not, there is a very good chance that the statute of repose has already expired. Without tolling, opting out of the settlement at that time will be self-defeating: it will be too late, by then, for individual class members who opt out to start their own lawsuit.

Statutes of Limitations Period for “Disgorgement” Claims. “Disgorgement” is a technical legal term that brings to mind regurgitation; and that is appropriate, because the term means that a wrongdoer must cough up the profits wrung from his or her wrongdoing. It is a favorite remedy often sought by the SEC and other government agencies. Given the long delays that have often occurred before agencies have brought cases related to the 2008 financial crash and other similar cataclysmic events, it is important to know how long these agencies have to bring these cases. Courts are often skeptical of claims that the statute doesn’t start to run for years because government watchdog agencies did not know about the wrongdoing, or could not have discovered it earlier.

Notably, courts, including the Eleventh Circuit, have held that there is no statute of limitations for injunctive and other equitable relief. The law has, until now, been mixed as to whether disgorgement is a form of equitable relief immune from the five-year statute of limitations. In Gabelli v. Securities and Exchange Commission, the Supreme Court held, in 2013, that § 2462 and its five-year statute apply to enforcement actions seeking civil penalties, and they must be brought within five years from the date when the defendant’s allegedly fraudulent conduct occurs, rather than when the fraud is discovered. In January, the Supreme Court granted certiorari in a case addressing a question left open by Gabelli: whether claims for disgorgement are subject to the same rule.

Under 28 U.S.C. § 2462, any “action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise, shall not be entertained unless commenced within five years from the date when the claim first accrued.” A case called SEC v. Kokesh has now raised the question of whether this five-year statute of limitations applies to claims for disgorgement or whether, instead, forfeiture is simply an equitable remedy to which no statute of limitations applies. The resolution of this issue will also have huge consequences for the SEC and other agencies seeking similar remedies in other cases.

Under 28 U.S.C. § 2462, the question is whether disgorgement is a form of penalty or forfeiture. The SEC had filed suit against Kokesh in 2009, accusing him of misappropriating money from four business development companies over a twelve-year period. The agency won a jury verdict against Kokesh in 2014, and the court ordered him to disgorge nearly $35 million, plus more than $18 million in prejudgment interest, and pay a $2.4 million penalty.

Kokesh appealed to the Tenth Circuit, arguing he shouldn’t have been ordered to cough up money he was paid before 2004 because of the five-year statute of limitations. The Tenth Circuit rejected Kokesh’s arguments in August 2016, holding that neither his disgorgement nor an injunction warning him not to violate securities laws were penalties, because neither remedy was a punishment. The Tenth Circuit sided with the D.C. Circuit and the First Circuit, which had also said the two types of recovery are different. But the decision conflicted with another from the Eleventh Circuit, which ruled in May that disgorgement is effectively the same as “forfeiture,” which is specifically limited to five years. Barring a lengthy fight over Senate confirmation, it seems likely that the ninth seat on the Supreme Court, left vacant by the death of Justice Scalia, will be filled by the time this case is briefed and argued.

SCOTUS Hears Oral Argument On Standards For Insider Trading

Attorney: Leigh Handleman Smollar
Pomerantz Monitor November/December 2016

We previously reported to you about the controversial decision by the Ninth Circuit, U.S. v. Salman, decided July 6, 2015, upholding an insider trading conviction. The court held that the “personal benefit” requirement did not require that the tipper receive a financial quid pro quo.  Instead, it held that it was enough that he “could readily have inferred [his brother-in-law’s] intent to benefit [his brother].” The court noted that if the standard required that the tipper received something more than the chance to benefit a close family member, a tipper could provide material non-public information to family members to trade on as long as the tipper “asked for no tangible compensation in return.”

The Salman decision was a departure from the holding in a 2014 Second Circuit Newman decision, which overturned the insider trading convictions of hedge fund managers, who received information down the line. The Newman decision interpreted the standard for “personal benefit” more strictly, finding that prosecutors must show that the tipper received a “tangible” benefit. The split amongst the circuits allowed the Ninth Circuit Salman decision to appeal to the Supreme Court of the United States. On October 5, 2016, SCOTUS heard oral argument on the issue of what constitutes “personal benefit” for purposes of insider trading. This is the first insider trading case to come before SCOTUS in 20 years. Specifically, SCOTUS considered whether insider trading includes tips on material, nonpublic information passed between relatives and friends, without any financial benefit to the tipper.

Prosecutors argued that a tipper who simply provides a “gift,” e.g., the tip, to family and friends, constitutes a benefit for purposes of insider trading. Opposing counsel argued that the benefit should be something that can be monetized. SCOTUS questioned both sides of the argument. While skeptical about giving prosecutors broad authority to determine whether the tip was a gift, SCOTUS seemed more skeptical in allowing insider trading only when the tipper gains a monetary benefit. Justice Anthony Kennedy said “you certainly benefit from giving to your family. . . It enables you and, in a sense it – it helps you financially because you make them more secure.” Justice Breyer stated, “to help a close family member is like helping yourself.” Justices Breyer and Kagan seemed to suggest that the defendants’ position would require SCOTUS to change the statute that has been used to prosecute insider trading for decades. The Justices seemed reluctant to do so, given the fact that such a holding would conflict with the SCOTUS 1983 decision in Dirks v. SEC, which held that insider trading violates the federal securities laws if an insider makes a gift of nonpublic information to a trading relative or friend.

The tougher question is whether the government’s position would apply to an unrelated friend, such as when a tipper tips nonpublic information to an acquaintance. The Justices seem to be struggling with where to draw the line. Justice Kagan seemed to suggest that they don’t need to draw the line on this more esoteric situation.

A ruling by the court should clarify what prosecutors must prove to secure insider trading convictions based on tipping, and how far the Justices draw the line.

Really Lost In Translation

Attorney: H. Adam Prussin
Pomerantz Monitor November/December 2016

TransPerfect is – or was -- a very successful, privately held company primarily engaged in language translation services. It has 3,500 full-time employees, half a billion dollars in annual revenue and 92 offices in 86 cities around the world. It maintains a network of more than 10,000 translators, editors, and proofreaders working in approximately 170 different languages.

Yet the company is tearing itself apart because its two founders can no longer get along. . . Elizabeth Elting and Philip Shawe founded TransPerfect almost 25 years ago in the dorm room they shared while attending NYU Business School. They were co-owners, co-CEOs, and the only company directors. Initially they were romantically involved, but Elting broke off their engagement in 1996 and eventually married someone else. This apparently did not sit well with Shawe, and 15 years later, when it was Shawe’s turn to get married, that didn’t sit well with  Elting either.

But the company they founded was so successful that neither wanted to walk away from it. Trying to force each other out, they began all-out warfare while the rest of management, and most of the employees, looked on in horror. Their sophomoric tantrums, retaliations, “hostage-taking” and other embarrassments have now been spelled out, in gory detail for the world to see, in a 104-page decision issued by the Delaware Chancery Court. The court, entering an unusual judgment forcing the sale of an immensely profitable company, concluded that

the state of management of the corporation has devolved into one of complete dysfunction between Shawe and Elting, resulting in irretrievable deadlocks over significant matters that are causing the business to suffer and that are threatening the business with irreparable injury, notwithstanding its profitability to date.

Most of the infighting involved petty power struggles over what otherwise would have been routine business decisions. But eventually their disputes escalated way out of control. Among a list of embarrassing episodes the court found that Shawe repeatedly burglarized Elting’s locked office, when she was away, to “dismantle” her computer hard drive so that he could read her thousands of confidential communications with her own lawyers; and that Shawe once filed a “domestic incident report” with the police, claiming that Elting had pushed him and kicked him in the ankle. According to the court, “Shawe identified Elting as his ex-fiancée, even though their engagement ended seventeen years earlier, apparently to ensure that the matter would be treated as a domestic violence incident and require Elting’s arrest.”

Before these two could completely destroy TransPerfect, the court granted Elting’s request that a custodian take it over and put it up for sale. Selling a successful company obviously runs the risk of destroying whatever it was that made it so successful for so long. In the end, though, the court determined that leaving these two to fight it out to the end was an even riskier bet.


Court Upholds Our Claims In Fiat Chyrsler Case

Attorney: Michael J. Wernke
Pomerantz Monitor November/December 2016

The district court for the Southern District of New York has substantially denied defendants’ motion to dismiss our complaint in Koopman v. Fiat Chrysler Automobiles N.V. et al. The complaint alleges Section 10(b) and 20(a) violations against the Fiat-Chrysler (“FCA”), CEO Sergio Marchionne, and the executive in charge of vehicle safety regulatory compliance.

The complaint alleges that defendants misled investors when they asserted that FCA was “substantially in compliance” with the National Highway Traffic Safety Administration’s (“NHTSA”) regulations. In truth, FCA had a widespread pattern of systemic regulatory violations dating back to 2013, in which FCA would delay required owner notification of defects and vehicle repair. Prior to defendants’ statements regarding compliance, NHTSA had at least twice written directly to Marchionne and the executive in charge of regulatory compliance, expressing concern about FCA’s regulatory violations/non-compliance. The truth was revealed on July 26, 2015, when NHTSA announced a Consent Order against FCA, fining the company a record-high $105 million and requiring a substantial number of recalls and repairs. Then on October 28, 2015, the company announced a $900 million pre-tax charge for an increase in estimated future recalls. The stock declined about 5% following each disclosure.

The court denied defendants’ motion to dismiss. It found that the complaint adequately alleged that defendants’ statements that FCA was “substantially in compliance” with the “relevant global regulatory requirements” were false when made. The court rejected defendants’ argument that violations in one country as to one regulator did not render such a broad statement misleading, agreeing with our argument that given the context of the statement the reasonable investor would conclude that FCA was in substantial compliance as to each area of regulation, including vehicle safety. The court also found that defendants’ statements regarding the “robustness” of FCA’s compliance systems and that they were “industry best” and similar statements were not puffery. However, the court found that the complaint failed to allege that the company’s statements of loss reserves for recalls, which were opinions, were false.

The court also found that the complaint adequately alleged scienter because defendants had received a letter from NHTSA expressing concern about certain compliance issues. The court also found that defendants repeated public discussions of compliance, access to reports identifying violations and the abrupt resignation of the compliance executive supported an inference of scienter.

Delaware Supreme Court Determines That Investor "Holder" Claims Belong To Them, Not The Company

Attorney: H. Adam Prussin
Pomerantz Monitor November/December 2016

In 1998, Arthur and Angela Williams became investors in Citigroup. They planned to sell all their shares in 2007; but because the company’s financial disclosures looked good at that time, they sold only 1 million shares, at a price of $55 per share, holding onto their other 16.6 million shares. 22 months later, after the financial meltdown of 2008, they sold the rest of their shares, for $3.09 per share, $800 million less than they would have received had they sold those shares when they originally planned. They then sued Citigroup and several of its officers and directors in federal court for failing to disclose Citigroup’s true financial condition, and thereby inducing them not to sell their shares.

One of the many issues in the case was whether their claim belonged to them or, rather, was a “derivative” claim that belonged to Citigroup. Because Citigroup is a Delaware corporation, the federal courts turned, for the answer to this question, to the Delaware Supreme Court. Its answer, in a recent en banc decision called AHW investment Partnership, was that the Williams’ claim was a direct claim that they could assert themselves.

In hindsight, this decision looks like a no-brainer. How could Citigroup be the owner of a claim seeking recovery from Citigroup, for false public statements Citigroup itself issued, which allegedly injured investors directly?

But here is the problem: Citigroup also suffered from whatever wrongdoing its officers and directors committed that led to the meltdown of its share price, including the financial misrepresentations made to its investors. So, could the same wrongs produce separate injuries and separate claims belonging to entirely different people? There was case law that suggested that the answer was no: a claim either belonged to the company or its shareholders, but not both. AHW says that, at least where the claims do not involve breaches of fiduciary duty, separate claims based on the same wrongdoing can belong to both.

A Distinction With a Difference. One of the many esoteric distinctions made by Delaware corporate law is between “direct” and “derivative” investor claims. Direct claims are those that belong to the investors personally, involving injuries that they have suffered directly. Derivative claims are those that belong to the company in which they have invested, and affect its investors only as an indirect result of injury to the company. Of course, anything that injures the company also injures its shareholders – but only indirectly. For example, if officers mismanage the company, that injures the company directly. Investors suffer the consequences, but, usually, only indirectly.

From a litigation standpoint this distinction has major consequences. In a direct suit any damages recovered go to the investors; but in a derivative suit, damages go to the company, not the investors. Moreover, from a tactical standpoint, while investors may pursue their own “direct” claims without restriction, they can prosecute derivative claims only if they can surmount the “demand” hurdle. Normally, investors are allowed to pursue derivative claims only if they can show that the directors are so conflicted that they cannot independently decide whether to pursue those claims. In such cases, demanding that the board bring a lawsuit would be “futile.” This “demand” requirement is often an insurmountable obstacle.

Many investor suits involve claims that the company’s directors have breached their fiduciary duties. Some of those duties run to the company itself, such as the duties of loyalty and care; others run to the shareholders directly, such as the duty of “candor” in communications made to investors. Sometimes these same duties can run in both directions. So Delaware law devised a legal test to distinguish whether fiduciary duty claims in a particular case are direct or derivative. In a 2004 decision named Tooley the Delaware Supreme Court held that this test involves two questions:

((1) who suffered the alleged harm (the corporation or the suing stock-holders, individually): and (2) who would receive the benefit of any recovery or other remedy (the corporation or the suing stock-holders, individually)?

The question, then, is either or: either the corporation owns the claim, or the investors do, but not both.

In Tooley, the investors claimed that the directors breached their fiduciary duties by improperly agreeing to postpone the closing of a merger, which delayed the payout of the merger consideration to the shareholders. The Court held that this was not a derivative claim because “there is no derivative claim asserting injury to the corporate entity. There is no relief that would go to the corporation.”

Since Tooley, many Delaware cases have held, or implied, that if the alleged injury is caused by a drop in the company’s stock price, the investors’ losses flowed from an injury to the corporation, and that under Tooley the claims must be derivative.

In AHW, for example, Citigroup argued that plaintiffs’ losses flowed from injuries suffered by the corporation, which caused the price of its stock to collapse. Nonetheless, AHW held that these individual investors had their own direct claim, based on representations made to investors. The court held that the Tooley “either/or” analysis for claims involving fiduciary duties did not apply to other types of claims.

AHW involved claims of common law fraud and negligent misrepresentation. These are typically considered to be direct claims that investors can pursue on their own behalf. If the Williamses had purchased or sold their shares based on these misrepresentations, there would have been no confusion; but because they were asserting so-called “holder” claims, alleging that they were  misled into holding onto their shares, their losses were traceable to injuries suffered by the company. AHW held that the Tooley analysis did not apply to claims that do not involve alleged breaches of fiduciary duty. The Court rejected the assertion that Tooley

was ―intended to be a general statement requiring all claims, whether based on a tort, contract, or statutory cause of action . . . to be brought derivatively whenever the corporation of which the plaintiff is a stockholder suffered the alleged harm. . . . when a plaintiff asserts a claim based on the plaintiff‘s own right, such as a claim for breach of a commercial contract, Tooley does not apply.

In other words, the Court is saying that if an investor asserts a non-fiduciary duty claim that is clearly personal to him, it makes no difference whether the investor’s losses flowed from an injury to the company.

The Second Circuit Holds That Fraud That Perpetuates An Inflated Stock Price Is Actionable

Attorneys: Emma Gilmore and Marc Gorrie
Pomerantz Monitor November/December 2016

In a recent decision in the long-running Vivendi case, the Second Circuit has issued a landmark ruling adopting the so-called “price maintenance” theory of securities fraud. This theory holds that investors can recover for fraudulent statements that did not push up the price of a company’s securities, but maintained that price at an artificially inflated level.

The Vivendi case is 14 years old and counting, one of the longest running securities fraud cases ever. It is also one of the few securities fraud class actions that ever went to trial. That trial lasted three months and, in January of 2010, a jury returned a verdict for plaintiffs, finding that Vivendi had recklessly issued 57 public statements that misstated or obscured its true – and dire –financial condition.

But the jury’s verdict almost seven years ago was far from the end of the story. The Supreme Court subsequently issued its decision in Morrison, holding that the federal securities laws do not apply to foreign securities transactions. As a result, class members who purchased Vivendi stock on foreign exchanges were excluded from the case. Since Vivendi is a French company, that ruling wiped out the claims of many class members, and potentially billions of dollars in judgments went down the drain.

Before awarding damages to other individual class members, the district court allowed defendants to try to prove that some of them, specifically certain sophisticated institutional investors, did not rely on defendants’ misstatements in buying their shares and therefore could not recover damages either. That dispute is what led to the Second Circuit’s decision adopting the “price maintenance” theory.

Background. In 1998, Compagnie Générale des Eaux, the French utilities conglomerate, changed its name to Vivendi and transformed itself seemingly overnight into a global media conglomerate by aggressively acquiring diverse media and communications businesses in the United States and abroad. Vivendi financed these leveraged mergers and acquisitions by issuing stock, but by 2002 the company was “running critically low” of cash and in serious danger of being unable to meet its financial obligations.

Vivendi did not disclose this, but instead made numerous representations to the market suggesting that its business prospects were robust.

Eventually a series of credit downgrades revealing Vivendi’s cash problems sent the company’s shares tumbling, and securities litigation ensued.

By mid-2002, consolidated class actions were filed in the Southern District of New York against Vivendi and its former CEO, Jean Marie Messier, and CFO, Guillaume Hannezo. Plaintiffs alleged that Vivendi violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 in issuing “persistently optimistic representations” denying the company’s near-bankrupt state, and that the CEO and CFO were liable as controlling persons under Section 20(a) of the

Exchange Act. As noted above, in 2010 the jury found for the plaintiff class against Vivendi, but exonerated the two individual defendants.

After trial, the district court ruled that Vivendi should be given the opportunity to show that sophisticated financial institutions had not relied on their misrepresentations in purchasing their shares. Vivendi claimed that plaintiffs failed to prove reliance because its misrepresentations merely maintained its stock price, rather than pushing it up. In its view, unless the price of the company’s stock actually rose as a result of a misrepresentation, there was no price impact and, therefore, no reliance. In this view, maintaining a pre-existing inflated stock price does not constitute a price impact.

The reliance requirement asks whether there is a “proper” connection between a defendant’s misrepresentation and a plaintiff’s injury. To resolve the difficulties of proving direct reliance in the context of modern securities markets, where impersonal trading rather than face-to-face transactions are the norm, the Supreme Court has held that a prospective class of plaintiffs could invoke a rebuttable presumption of reliance by invoking the “fraud on the market theory,” which provides that “[a]n investor who buys or sells stock at the price set by the market does so in reliance on the integrity of that price,” where material information about the company (including  any fraudulent public statements) are reflected in the market price. Investors are all presumed to rely on the “integrity” of that market price when they purchase shares. Thus, part of what they are relying on, indirectly, are the fraudulent statements.

In Halliburton, however, the Supreme Court held that the fraud on the market theory creates only a presumption of reliance, and defendants are entitled to try to rebut that presumption in particular cases. In Vivendi the company argued that it had rebutted that presumption by showing that its stock price did not increase after most of the alleged misstatements, and therefore those misstatements had no effect on the investors’ decisions to invest.

The district court rejected that argument, accepting the so-called price maintenance theory. This theory, which is being debated in federal courts all over the country, holds that plaintiffs do not have to show that the fraudulent statements pushed the stock price up. Rather, the theory posits that fraud that artificially maintains the inflated market price of a stock does have a price impact and therefore supports investors’ claims that they relied on the integrity of the market price when they purchased their shares.

Vivendi appealed.

Second Circuit Decision. Delivering a major victory for investors, the Second Circuit, in its Vivendi decision, embraced the price maintenance theory for the first time. It joined the Eleventh and Seventh Circuits in rejecting the idea that a fraudulent statement, to be actionable, must always introduce “new” inflation into the price of a security. The Second Circuit analyzed Vivendi’s contention as resting on two premises: that the artificial inflation in the company’s share price caused by the market’s misapprehension of the company’s liquidity risk would not have dissipated had Vivendi remained silent and that Vivendi had the option to remain silent, thus permitting the preexisting inflation to persist. In other words, Vivendi argued that their fraudulent statements had no impact because its stock price would have remained inflated anyway had it just said nothing.

The Second Circuit rejected that argument. First, it held that it was not necessarily true that the stock price would have remained unchanged if Vivendi had said nothing:

Perhaps, in the face of silence, inflation could have remained unchanged. But it also could have plummeted rapidly, or gradually, as the truth came out on its own, no longer hidden by a misstatement’s perpetuation of the misconception. . . . It is far more coherent to conclude that such a misstatement does not simply maintain the inflation, but indeed “prevents [the] preexisting inflation in a stock price from dissipating.”

Second, it held that because it chose to issue statements about its financial condition, Vivendi had no option to remain silent about its liquidity problems:

Vivendi misunderstands the nature of the obligations a company takes upon itself at the moment it chooses, even without obligation, to speak. It is well established precedent in this Circuit that “once a company speaks on an issue or topic, there is a duty to tell the whole truth,” “[e]ven when there is no existing independent duty to disclose information” on the issue or topic.

Thus, far from being a “fabricated” and “erroneous” argument, as Vivendi labeled it, the Second Circuit said that the price maintenance theory prevents companies from “eschew[ing] securities-fraud liability whenever they actively perpetuate (i.e., through affirmative misstatements) inflation that is already extant in their stock price, as long as they cannot be found liable for whatever originally introduced the inflation. Indeed, under Vivendi’s approach, companies (like Vivendi) would have every incentive to maintain inflation that already exists in their stock price by making false or misleading statements.  After all, the alternatives would only operate to the company’s detriment: remaining silent, as already noted, could allow the inflation to dissipate, and making true statements on the issue would ensure that inflation dissipates immediately.” After discussing the theory with approval and at length, the Second Circuit concluded:

In rejecting Vivendi’s position that an alleged misstatement must be associated with an increase in inflation to have a “price impact,” we join in the Seventh and Eleventh Circuits’ conclusion that “theories of ‘inflation maintenance’ and ‘inflation introduction’ are not separate legal categories . . . Put differently, we agree with the Seventh and Eleventh Circuits that securities fraud defendants cannot avoid liability for an alleged misstatement merely because the misstatement is not associated with an uptick in inflation.

Wells Fargo Joins The Long List Of Misbehaving Banks

Attorney: H. Adam Prussin
Pomerantz Monitor September/October 2016

Although this was a tiny fraud, by bank standards, it hit home harder than most. Unlike the typical bank horror story, this one did not involve machinations in the sales of complex securities by one financial behemoth to another. Instead, it targeted regular retail customers of the bank, who were victimized by nickel and dime chiseling by over 5,000 low-level Wells Fargo employees. Because victims were mostly everyday people, this story cut through the election year noise and reminded us how bad these people are.

Despite the massive wealth of many banks, retail bank employees are among the lowest paid workers on earth, many earning around $10 an hour. In this case, Wells Fargo reportedly made their lives even more miserable by imposing extremely aggressive sales targets on them if they wanted to keep their jobs or, possibly earn a little Christmas bonus. These sales were supposed to  be generated by “cross-selling” additional accounts or services to existing Wells Fargo retail customers. While there is nothing wrong with a bank providing incentives to employees to boost sales, in this case these were really quotas, which were so high that employees usually could not meet them legitimately. So, according to the Consumer Finance Protection Bureau, some 5,300 or so Wells Fargo employees opened about 1.5 million unauthorized deposit accounts in the  name of unsuspecting customers and made about 565,000 unauthorized credit card applications, generating about $2.6 million in fees and enabling themselves to keep their jobs.

Years ago, Wells Fargo got wind of this illicit activity, and it apparently made their employees attend “ethics training” courses where they were repeatedly told to stop their fraudulent behavior. The bank supposedly hired more and more “risk managers” to try to prevent it as well. But the crazy sales quotas remained in place. Not surprisingly, then, the misbehavior continued for over five years. Reportedly, many Wells Fargo employees felt that they had no choice but to do whatever it took to meet the bank’s impossible sales quotas, or else face termination.

As is typical in cases involving bad bank behavior, once the wrongdoing was publicly exposed, only the little people were held responsible. So far, no one has identified a single member of management who got the axe for failing to prevent or stop this conduct.

Some have suggested that the bank should “claw back” bonuses that were awarded based on phony sales reports. Perhaps they should start by looking at Carrie Tolstedt, the divisional senior vice president for community banking, who was in charge of Wells Fargo’s 6,000 branches where the infractions took place. In the last three years, she was paid a total of $27 million. Although she stepped down in July, she remains employed by the bank until the end of the year. When she leaves, she will probably be able to take with her nearly $125 million in stock and options.

In the end, the bank agreed in September to pay a fine of $185 million. When this agreement was announced, the bank’s stock dropped about 7.5%, cutting its market capitalization by $19 billion.

On September 20, 2016, Charles Stumpf, CEO of Wells Fargo, testified before the Senate Banking Committee, and repeated his claim that this fraud was the work of a handful of “bad apples.” That argument did not sit well. Senator Elizabeth Warren blasted him, saying that “you should give back the money that you took while this scam was going on and you should be criminally investigated by both the Department of Justice and the Securities and Exchange Commission. This just isn’t right. A cashier who steals a handful of $20s is held accountable. But Wall Street executives almost never hold themselves accountable.”

Distinguished Federal District Judge Shira Scheindlin Retires

Attorney: Adam G. Kurtz
Pomerantz Monitor September/October 2016

Federal District Court Judge Shira Scheindlin of the Southern District of New York stepped down from the bench in April of 2016. Over the past two decades “Judge Scheindlin was one of the hardest working and scholarly judges that I had the honor of appearing before in court, as well as working with in law symposiums,” according to Pomerantz partner, Marc Gross. When appearing before Judge Scheindlin, Mr. Gross noted that “[s]he was always incredibly prepared, even on the most esoteric economic issues, asking pointed questions that kept witnesses and counsel on their toes.” Over the years, Mr. Gross and Judge Scheindlin have also appeared together at law symposiums, including the Annual Institute For Investor Protection Conference, to speak about securities fraud class actions.

Judge Scheindlin has had a 22-year history of presiding over important securities, antitrust and civil rights class action, cases, and writing landmark case law decisions. Several of them were cases in which Pomerantz represented investors and consumers. Most recently, Pomerantz had great success in an important securities fraud (Barclays) and antirust (NHL & MLB) cases that were before Judge Scheindlin.

In April 2015, in the “Dark Pool” Barclays’ securities fraud case, Judge Scheindlin denied defendant Barclays’ motion to dismiss, and in February 2016, granted plaintiffs’ motion for class certification and appointed Pomerantz as lead class counsel. This case concerns Barclays’ false statements regarding the integrity of its “dark pool,” an alternative trading platform that does not reveal the size and price of the anonymous trade. Judge Scheindlin’s case law decision was important because of its emphasis on the critical importance (“materiality”) to investors of management integrity. The decision not only granted class investors and Pomerantz a legal victory, it advanced the important legal standard that false and misleading statements about management integrity could be the foundation of a securities fraud case, even if the amount of money involved is not particularly great. Judge Scheindlin’s class certification decision is now on appeal before the Second Circuit Court of Appeals.

As one of her final orders, just before she stepped down from the bench, Judge Scheindlin granted final settlement approval “of a lawsuit brought by fans [against Major League Baseball and cable TV providers] over how games are broadcast, a crack in the dam the league and pay TV have built against unrestrained viewing,” according to an article entitled “MLB Settlement Gives Baseball Fans Viewing Options,” on Bloomberg.com. Pomerantz was co-lead class counsel. More specifically, the antitrust cases challenged MLB and NHL’s “black out” prohibitions of teams from broadcasting or streaming games outside their home and inside outer market territories. Judge Scheindlin concluded that the settlement – worth $200 million to consumers – will lower the price to watch baseball online and increase online viewing options so that (1) fans can watch a favorite team, without blackouts, by subscribing to cable TV and MLB.com; (ii) out of town fans can buy discounted single team online streaming packages; and (iii) hometown fans can stream to all devices. In the parallel NHL case, the NHL settled and agreed to provide NHL fans with previously unavailable single-team packages at prices well below the out-of-market bundled package.

However, Marc Gross says, “Judge Scheindlin’s greatest contribution was in the arena of social justice and civil rights. She was the first judge in the country to find that certain police tactics (in this case “stop and frisk”)  were applied in a discriminatory manner, and therefore, were unconstitutional. This was before the “choke hold” and police shooting deaths, and before Ferguson and Black Lives Matter. Her decision allowed New York City and its police to rapidly move forward to address questionable policing tactics, thereby undoubtedly helping to avoid much of the turmoil experienced by other cities.”

In the wake of her decision, the number of “stop and frisks” dropped from 685,000 in 2011 to 24,000 in 2015. In May 2016, Judge Scheindlin told Benjamin Weiser of The New York Times, “Think of the lives that that has changed, the lives that that has touched,the lives of people who  were stopped for no good reason and how intrusive that is.” The policy had “bred nothing but distrust,” she added. During this same period, major crime in NYC overall dropped 5.8% in the two years since Judge Scheindlin’s decision. “As we end [2015], the City of New York will record the safest year in its history, its modern history, as it relates to crime,” NYPD Commissioner Bratton said.

Judge Scheindlin has said, “I do what I think is right, and whether the circuit [appeals court], the press, the public or whoever think it’s right doesn’t matter. Should it? . . . What I hope to do are even more good works than I could accomplish here [as a Judge].”


Supreme Court To Revisit “Personal Benefit” Requirement For Insider Trading Convictions

Attorney: Omar Jafri
Pomerantz Monitor September/October 2016

The Supreme Court has agreed to hear a case next term involving the standards for insider trading convictions. At issue is whether the government must prove that a corporate insider (the tipper) received a personal benefit of a “pecuniary or similarly valuable nature” in exchange for disclosing confidential information to a remote tippee. In the case in which certification was granted, U.S. v. Salman, the Ninth Circuit held that the “personal benefit” requirement was satisfied when the tipper, Maher Kara, a former investment banker at Citigroup, leaked  confidential information about mergers and acquisitions in the healthcare industry to his older brother, Michael, who, in turn, passed it on to Maher’s brother-in-law, Salman.

Maher and Michael pled guilty and cooperated with the government during Salman’s trial. Maher testified that he willingly disclosed confidential information to “benefit” Michael and “fulfill whatever needs he had.” Michael testified that he told Salman that Maher was the source of the information, and that Salman agreed to “protect” Maher from exposure. The Ninth Circuit concluded that, in light of the parties’ close-knit relationships, Salman must have known that Maher intended to benefit his elder brother when he leaked the confidential information. Based on these facts, the Ninth Circuit upheld Salman’s conviction on the ground that Maher gave “a gift of confidential information to a trading relative or friend,” and there was sufficient evidence to conclude that Salman knew that Maher personally benefited from the disclosure.

In affirming Salman’s conviction, the Ninth Circuit relied on Dirks v. SEC, where the Supreme Court held that an insider trading conviction requires that the tipper must receive a personal benefit in exchange for leaking confidential information to a tippee. In Dirks, the Supreme Court defined a personal benefit to the tipper as a “pecuniary gain,” “a reputational benefit” or “a gift of confidential information to a trading relative or friend.”

In concluding that Salman’s conduct constituted “a gift of confidential information to a trading relative or friend,” the Ninth Circuit rejected Salman’s request to adopt the Second Circuit’s novel and restrictive approach towards insider trading cases. In U.S. v. Newman, the Second Circuit held two years ago that a close personal or familial relationship between the tipper and the tippee, without more, is not sufficient to show that the tipper obtained a personal benefit unless the government proves that the tipper received “ . . . at least a potential gain of a pecuniary or similarly valuable nature.” In October 2015, the Supreme Court denied the government’s request to review the Second Circuit’s decision in Newman.

In our view, the Second Circuit’s approach contradicts the Supreme Court’s holding in Dirks that a “gift of confidential information to a trading relative or friend” constitutes a personal benefit. The legal and ordinary definitions of the term “gift” do not contemplate an exchange, consideration or any kind of “pecuniary” or “similarly valuable” benefit in return. For over thirty years, convictions based on insider trading have been sustained even if the tipper did not receive a tangible benefit in exchange for breaches of fiduciary duties and the consequential disclosure of material, nonpublic information. Until Newman was decided in 2014, every Circuit held that the law does not require a tipper to obtain a pecuniary benefit, and every Circuit to rule on the issue since Newman has held the same. While the Second Circuit paid lip service to Dirks’ holding by acknowledging that its prior precedent broadly defined a personal benefit to include a “gift of confidential information,” the new rule it crafted in Newman has upended well-settled law and wreaked havoc on the justice system. Several high-profile convictions and guilty pleas entered in courts in the Second Circuit have been set aside based on Newman.

To the extent that the three-judge panel in Newman chose to adopt a more restrictive approach to provide clarity and certainty in the law, the effort seems to have failed. In a recent trial in New York City, a former investment banker was convicted of insider trading based on leaking confidential information about healthcare mergers to his father. The government argued that the defendant obtained a pecuniary benefit because his father paid certain expenses in connection with the defendant’s wedding. Defendant, however, claimed that the wedding expense payments were not a “pecuniary benefit” but were, instead, a “gift.” Friends and relatives give gifts to each other all the time. Drawing such distinctions brings us right back into a gray area subject to endless uncertainty.

In urging the Supreme Court to adopt the Second Circuit’s standard and limit convictions to instances where an insider obtains a “potential gain of a pecuniary or similarly valuable nature,” Salman argues that the Ninth Circuit’s approach raises separation-of-powers and Due Process concerns, and delegates to prosecutors the power to legislate by defining, on an ad hoc basis, the kinds of personal benefits that can make the difference between guilt and innocence. Over the last decade, the Supreme Court, including Justices on both sides of the ideological divide, has been increasingly receptive to these types of arguments when high-profile white collar criminal defendants or powerful politicians accused of corruption are involved. For example, two months ago, the Supreme Court overturned the conviction of Virginia’s ex-governor, in part, because it held that ingratiation and access in exchange for lavish gifts and money does not constitute corruption. That decision was unanimous. Whether it will influence the Court’s decision in Salman remains to be seen.

Oregon Court Holds Exorbitant Executive Compensation For Past Services Raises Doubt That Directors Exercised Valid Business Judgment

Attorney: Darya Kapulina-Filina
Pomerantz Monitor September/October 2016

In a recent victory before the Circuit Court of Oregon, the court upheld Pomerantz’s shareholder derivative complaint against the board of directors of Lithia Motors, Inc. The case stems from an agreement approved by the board for exorbitant compensation to be paid to Lithia’s founder and CEO, Sidney DeBoer, following his resignation. The compensation package entailed annual payments of $1,050,000 for the remainder of DeBoer’s life, a $42,000 car allowance, and continued reimbursement for premiums on DeBoer’s insurance policies. None of these payments were required by DeBoer’s existing employment agreement and, therefore, amounted to a going-away present from the company. The complaint we filed alleged that by approving this giveaway, the board breached its fiduciary duties of care and loyalty and committed waste of corporate assets, resulting in DeBoer’s unjust enrichment.

This is a derivative case, brought by shareholders on behalf of the corporation. Under Oregon law, which is analogous to Delaware law, a complaint in a derivative action must allege either that, prior to commencing the lawsuit, shareholders made a demand on the board to take corrective action to avoid litigation, or that demand was excused because it would be “futile” or an “idle gesture.” Plaintiffs are typically excused from making a demand if they can show specific facts demonstrating that there was reasonable doubt that (1) the majority of directors are disinterested or independent; or (2) the transaction was a valid exercise of business judgment (more on business judgment below). The plaintiff shareholders in Lithia did not make the pre-litigation demand on the board, but included facts in the complaint which we contended showed that demand would have been futile.

The board moved to dismiss our case, arguing that pre-suit demand was not excused and that, in any case, the complaint failed to state a claim for breach of fiduciary duties, corporate waste, or unjust enrichment. The court upheld each of our claims. It held that there is reasonable doubt as to the independence of three out of the seven Lithia directors named in the lawsuit, but three out of seven did not make up a majority. The court went on to analyze whether there was reasonable doubt that the challenged transaction was otherwise the product of a valid exercise of business judgment. The court found that plaintiffs met their “heavy burden” through “particularized facts” in the complaint showing that:

(1) DeBoer would receive his benefits in consideration of his prior services. The court agreed with plaintiffs that past services are not valid consideration for these payments.

(2) The board chose not to retain a compensation consultant and provided no analysis of what other departing executives typically receive.

(3) The board delegated full authority to director William Young to approve the final agreement, and Young had to practically force other members of the Compensation Committee to review the Transition Agreement.

(4) DeBoer’s Transition Agreement was not approved by the company’s audit committee.

(5) DeBoer’s compensation was disproportionately higher than designated in Lithia’s “Change of Control Agreement” which specifies compensation payable to him in the  event of a sale of all or substantially all of the assets of Lithia, any merger, consolidation or acquisition, or any change in the ownership of more than fifty percent (50%) of the voting stock.

Given these facts, the court found that “plaintiffs have plead particularized facts in their complaint which create a reasonabledoubt that the transaction was a product of validbusiness judgment . . . [and] plaintiffs raise a reason to doubt that the directors were adequately informed in making their decision.” As a result, the shareholders were excused from making a pre-litigation demand on the board.

The court went on to uphold each of plaintiffs’ substantive claims. As for our claims against DeBoer, It held that just because he did not personally vote on whether to approve his compensation, he was nonetheless potentially liable for a breach of fiduciary duties claim for “indirectly engaging in the transaction.” The court relied on the shareholders’ allegations that:

(1) DeBoer, owning 52% of the votes, admittedly can cause the company to enter into agreements with which other stockholders do not agree.

(2) DeBoer engaged in a self-dealing transaction.

(3) The board “generally failed to cleanse the taint of self-interest and should have obtained shareholder approval.”

The court upheld the waste of corporate assets claim, relying on plaintiffs’ allegations that the compensation in question was in exchange for past services and was beyond what the compensation committee deemed fair. It found that plaintiffs’ allegations “suggest an unreasonable exchange” because according to Lithia’s Change of Control Agreement, the Transaction Agreement over compensated DeBoer by 1,000%.

Finally, the court upheld plaintiffs’ unjust enrichment claim on the basis that DeBoer’s compensation was for past services rendered, for which DeBoer had already been compensated.

The Lithia decision is instructive to other shareholders who need to overcome the test for demand futility but are not able to establish that the majority of the board of directors were conflicted. Shareholders can overcome business judgment and establish doubt as to the board’s informed decision-making and valid exercise of judgment by detailing the insufficient manner in which directors handled the questioned transaction. Some aspects to highlight in a derivative complaint include:

• Were draft agreements presented to the board or committees (compensation committee, audit committee, special committee)?

• Were questions raised by the board or was the transaction rubber stamped for approval?

• What was the review process and duration of the evaluation of the transaction?

• Did the board retain an outside expert or consultant?

• Was a legal advisor retained to review the propriety of the transaction? The Lithia court cited a case involving executive compensation of the president of the Walt Disney Company where the compensation committee met for less than an hour, asked no questions, gave no presentations, did not engage an expert consultant, and approved the exorbitant payments.

• How does the transaction compare with others? Was any comparable transactions analysis made?

• What benefit does the transaction provide to the company and shareholders?

• Was shareholder approval obtained?

Although shareholders still face a heavy burden to overcome the business judgment rule in the context of a demand futility issue, the Lithia decision gives hope to shareholders that courts will not just assume the board took adequate measures in approving a questionable transaction such as excessive executive compensation payouts, but may scrutinize the board’s review process.

In doing so, they can even allege defendants’ federal-law violations for similar conduct.


Decision Certifying Class In Petrobras Case Heads To Second Circuit

Attorney: John A. Kehoe
Pomerantz Monitor September/October 2016

As the Monitor has previously reported, the court has appointed Pomerantz as lead counsel for a class of purchasers in the U.S. of securities issued by Petrobras, a Brazilian corporation engulfed in a massive corruption scandal. We were retained in this case, which is pending in the Southern District of New York, by lead plaintiff in the action, Universities Superannuation Scheme Ltd., and by a U.S. state retirement plan. Plaintiffs allege that the fraud that pervaded Petrobras artificially inflated the price of Petrobras securities by billions of dollars, while in the process hobbling the political and economic structure of Brazil, one of the world’s largest economies.

In February, Judge Rakoff certified a class of purchasers of Petrobras securities on a U.S. exchange or through other domestic transactions between January 22, 2010 and July 28, 2015 for claims arising under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. In addition, for claims asserted under Sections 11 and 12(a)(2) of the Securities Act of 1933, Judge Rakoff certified a class of purchasers of Petrobras debt securities in U.S. domestic transactions in/or traceable to public offerings that Petrobras conducted on May 15, 2013 and March 11, 2014.

The classes were limited to investors who engaged in securities transactions in the U.S. because of the Supreme Court’s decision several years ago in a case called Morrison v. Nat’l Australia Bank (“Morrison”), where the Court held that U.S. securities laws apply only to domestic transactions. The Petrobras class certification motion turned largely on whether the question of where each investor’s purchases occurred presents individual issues that would “predominate” over common questions in the case. In certifying the class, Judge Rakoff found that “the Morrison determination is administratively feasible” in a class action. In particular, Judge Rakoff determined that:

The criteria identified by [the Second Circuit], as relevant to the determination of whether a transaction was domestic, are highly likely to be documented in a form susceptible to the bureaucratic processes of determining who belongs in a class.  For example, documentation of ‘the placement of purchase orders’ is the sort of discrete, objective record routinely produced by the modern financial system that a court, a putative class member, or a claims administrator can use to determine  whether a claim satisfies Morrison.

In addition to challenging this finding, Petrobras also challenged Judge Rakoff’s finding that market efficiency for Petrobras securities was sufficient to satisfy the fraud-on-the-market theory. This theory makes it possible to establish the element of reliance, which is required for such claims, on a class-wide basis.

Petrobras filed an interlocutory appeal, and in June the Second Circuit agreed to hear Petrobras’ appeal, on an expedited basis.

Since that time, numerous amicus briefs from non-parties have been submitted in support of Judge Rakoff’s decision. Notably, the National Conference of Public Employee Retirement Systems (“NCPERS”) filed an amicus brief in support of class certification. NCPERS is the largest national, non-profit public pension trade association. With respect to the Securities Act claims related to the note purchases, and in particular with respect to the issue of whether determining whether a transaction occurred in the U.S., NCPERS asserts that the class as certified is sufficiently ascertainable through ordinary documentation that would be submitted during an administrative claims process, and that limiting the class to purchasers in domestic transactions does not render the class indeterminate, unfair to class members or defendants, or otherwise defective. Recognizing that the Supreme Court in Morrison and the Second Circuit in Absolute Activist Value Master Fund Ltd. v. Ficeto set forth straight-forward criteria for analyzing the domestic transaction requirement, NCPERS contends that the types of proof needed to establish the elements of a domestic transaction typically are readily available and amenable to the ordinary claims administration processes in securities cases.

Similarly, the State Board of Administration of Florida (“SBA”) also filed an amicus brief supporting the judge’s decision on the domestic versus foreign transaction issue, although its argument was far broader. The SBA, governed by a three-member Board of  Trustees that includes the Governor, Chief Financial Officer, and the Attorney General of the State of Florida, has over $170 billion in assets under management. The SBA argues that all trades in Petrobras notes, regardless of their origins, should properly be regarded as occurring in the United States because the notes are themselves housed at the Depository Trust Company (“DTC”), located in the United States, and all transactions in those notes occur through DTC’s process of “settlement,” when the notes are debited from the seller’s brokerage account and deposited into the buyer’s brokerage account. Such transactions bear all the hallmarks of title transfers and take place entirely within DTC’s self-contained electronic system in the New York area, making all trades within that system—including those in Petrobras notes—domestic. Transactions settling through DTC utilize the same method of transfer as all trades on domestic exchanges. This principle would render all trades in these securities automatically “domestic” and would eliminate this as an issue on class determination.

Amicus briefs have also been submitted by twelve distinguished securities law professors on the issue of market efficiency. They note that the fraud-on-the-market presumption of reliance has long been understood as placing a necessarily high burden on a defendant to prove that the alleged misrepresentation did not actually affect the stock’s market price, and that this burden should apply with equal force at the class certification stage. They contend that the Second Circuit should endorse this approach, as it best reflects the realities of the modern securities markets and the rationale behind the fraud-on-the-market doctrine.

Remarkably, another group of distinguished professors who teach, research, and write about the laws of evidence filed an amicus brief supporting certification as well. They argue that principles of the law of evidence dictate that, once plaintiffs have satisfied their burden of triggering the fraud-on-the-market presumption of reliance, the burden of persuasion shifts to the defendants to rebut that presumption by a preponderance of the evidence. Contrary to Petrobras’ argument, these evidence scholars, several of whom were involved in drafting the Federal Rules of Evidence, argue that with respect to the presumption of reliance under the securities laws, the congressional policy requires shifting the burden of persuasion to defendants in evaluating whether the presumption of reliance has been rebutted.

As the professors aptly note, Basic Inc. v. Levinson (“Basic”) and Halliburton Co. v. Erica P. John Fund recognize that such an allocation of the burden of persuasion is necessary to further Congress’s purpose underlying the securities laws: namely, to give investors reasonable protection when they buy and sell securities. Furthermore, the evidentiary scholars assert that the fraud-on-the-market presumption is triggered only on a substantial showing by plaintiffs, much greater than is required to trigger many other presumptions, and thus a defendant’s burden on rebuttal should be more substantial as well. Reference in Basic to the Advisory Committee note on the original version of Rule 301, which required a substantial rebuttal burden, supports the conclusion that a substantial rebuttal burden is required to rebut market efficiency. Indeed, most district courts have adopted the rule that defendants must rebut the presumption by a preponderance of the evidence.

Oral argument is scheduled for November 2, 2016.

Pomerantz Recognized As A Global Leader By The Legal 500

Pomerantz Monitor July/August 2016

Pomerantz is honored to have been chosen by The Legal 500 as a leading firm in 2016. The Legal 500 is the world’s largest legal source, with over 4.5 million viewers. It assesses law firms across the globe, selecting for its ranks only top-tier firms that are the most cutting-edge, innovative and successful.

Here’s what The Legal 500 has to say about Jeremy Lieberman, Pomerantz’s Co-Managing Partner:

 “In New York, Jeremy Lieberman is ‘super impressive – a formidable adversary for any defense firm.”

Patrick Dahlstrom, Pomerantz’s Co-Managing Partner, says, “We have been at the forefront of shareholders’ rights and recoveries for corporate malfeasance in the United States for over 80 years, and are honored to be recognized by The Legal 500 as we work to expand those rights and remedies to investors around the globe.”

Has The Curtain Finally Fallen On The Galanis Family Of Fraudsters?

Attorneys: H. Adam Prussin and Jessica N. Dell
Pomerantz Monitor July/August 2016

This month Jason Galanis and his father John Peter Galanis both entered guilty pleas for their roles in swindling Gerova Financial Group investors. They admitted to manipulating the company’s stock price using a maze of small companies and a straw buyer to conceal their involvement. They agreed to forfeit over $37 million in assets and will both be sentenced in December. Other alleged conspirators include Jason’s two brothers, Jared and Derek Galanis.

If the names sound familiar, it is because the family has bounced from one colorful financial scandal to the next for over thirty years. Five years ago, Pomerantz filed suit for Gerova Investors based on the same violations. That suit was successfully settled. The Galanii currently also face criminal charges alleging that they bilked $60 million from members of the Sioux Nation in South Dakota. In the last two decades, they have reportedly dabbled in gambling, porn, and Kosovo drug rings. It was reported that two months ago, while out on bail and facing criminal charges, Jason Galanis got drunk on an airplane and sent threatening texts to a former friend he thought was cooperating with federal investigators. His bail was consequently revoked.

Although Galanis Senior, the Bernie Madoff of the eighties, served years in prison, investors were never made whole. Throughout that decade, he faced a litany of charges, including stealing hundreds of millions from investors, and millions from the government in false tax deductions. In 1988 he was convicted on 44 felony counts and ultimately sentenced to 27 years in a federal prison. When the sentence was handed down, then U.S. Attorney Rudy Giuliani told the press he hoped it would send a message that: “those like Galanis...who are involved in multimillion-dollar frauds and corruption will realize that no matter how wealthy or how powerful they believe they are, no matter how complex their scheme, they too can be brought to justice.” If the sentence indeed had any deterrent effect, it was short-lived. Perhaps this time, by rounding them all up at once, we can hope again that U.S. District Attorney Bharara has succeeded in shuttering the Galanis family business for good. 

International Portfolio Monitoring And Its Increasing Importance To Pension Funds

Attorney: Jennifer Pafiti
Pomerantz Monitor July/August 2016

The United States sees hundreds of new securities class actions filed each year as well as approximately 100 class action settlements. For many institutional investors, the task of obtaining and tracking all this information is too complex and too expensive to do in-house; nevertheless, it remains essential that pension fund fiduciaries are regularly informed of the extent to which the value of the publicly traded investments they oversee may be diminished by financial misconduct. Increasingly, financial institutions have been turning, for help, to professional portfolio monitoring services.

Increasingly, fiduciaries must now also keep abreast of investor class actions filed abroad. In June 2010, the U.S. Supreme Court decided, in Morrison v. National Australia Bank, that U.S. federal securities law remedies were limited to investors that had purchased relevant securities only on a U.S. stock exchange. In the wake of this decision institutional investors began to realize that they could no longer limit their portfolio monitoring to activity in the U.S. They would need to have their global portfolio monitored by a team equally dedicated to both domestic and international monitoring services.

In the six years since the Morrison decision we have seen more and more litigation activity outside of the U.S.; in particular, (but not limited to) countries with collective redress procedures and securities laws closest to that of the U.S. In the past few years Australia, Canada, the Netherlands, and the United Kingdom have emerged as front runners for pursuing shareholder class actions outside of the U.S. for varying reasons. Here, we examine those merging venues to better understand them.

In Canada and Australia, class action procedures and pro-investor measures have recently combined to allow a steady stream of offering and open-market type claims to yield substantial recoveries.

The number of securities class actions initiated in Australia is growing. An essential feature of the Australian class action system is that there must be seven or more plaintiffs with claims arising out of the same or similar circumstances with substantial common issues of fact or law in question. Compared with many overseas jurisdictions, this is a fairly low threshold and makes Australia a class action friendly jurisdiction.

Australia is officially an “opt-out” jurisdiction (meaning that to be excluded from a class, the class member must formally exclude himself or herself from the class), and employs a “loser pays” system where the losing party may be liable for both their legal costs and that of the prevailing party. This often means that parties will bring in external litigation funders who will take a percentage of the class recovery if successful and hold the fee “risk” if the case is lost. This has effectively resulted in “closed classes” in which only those class members who have agreed to litigation funding are included in the class action and can participate in any recovery. To date, no securities class action filed against a publicly traded company in Australia has proceeded to judgment. Instead, the claims that have concluded have been settled outside the courtroom.

Last year, Canada saw only four new securities class action filings, whereas the U.S. sees roughly 150 new securities class actions filed each year. Most Canadian provinces have adopted an “opt-out” procedure whereby an investor is automatically included in the class unless they affirmatively “opt-out.” Like Australia, Canada has an active third-party litigation funding regime requiring investors to “opt-in” in order to participate in any recovery.

The Netherlands is a unique jurisdiction in that Dutch law enables the formation of settlement foundations (stichting) to bring collective redress for parties wishing to create a binding, European-wide settlement. Resembling the U.S. “opt-out” system, parties have the right to “opt-out” during the defined period set by the court.

An interesting component of the Dutch settlement system is that a significant connection between the conduct complained of and the Dutch jurisdiction is not required. This has led to the suggestion that foreign parties may flock to the Netherlands to seek redress. Notwithstanding this, the Netherlands is yet to be described as a hotspot for international securities class actions.

Unlike the other jurisdictions described above, the U.K. lacks a class action procedure. However, a group litigation mechanism exists whereby individual cases involving the same circumstances against the same defendants are grouped together. Only those claimants who are affirmatively named are included in the litigation and bound by the judgment (similar to “opt-in”). The U.K. adopts an unattractive “loser pays” system. The absence of litigation funders, changes in after-the-event insurance and the “loser pays” system have deterred investors from filing suit there. Nevertheless, the case currently proceeding in the U.K. against the Royal Bank of Scotland (“RBS”), in connection with its 2008 rights issue, is unprecedented in the U.K. and is being closely watched in terms of how the group litigation is being managed and how any loser-pays costs will be distributed. In recent years there has been much demand in the U.K. for a U.S.-style class action procedure to be introduced into legislation. Some argue that, at present, the U.K. government has no interest in changing legislation that would open the floodgates for investors to sue RBS – a bank in which the government has an 83% stake.

Determining whether to become involved in securities litigation outside the U.S. requires examination of near identical issues to be considered when taking affirmative action in the U.S., in addition to consideration of varying jurisdictional statutes of limitations, cost issues, and analysis of what types of losses are compensable.

It is prudent that pension fund fiduciaries are provided with both domestic and international portfolio monitoring services, coupled with comprehensive legal advice so that they can make informed decisions on what action, if any, they take to recover their losses.

Note: Pomerantz provides a no-cost portfolio monitoring service whereby clients receive monthly, personalized reports quantifying losses in new actions relating to the U.S. and worldwide, providing legal advice in respect of those losses and highlighting upcoming claims filing deadlines for settled securities class actions in which the fund is eligible to participate. For more information, please contact the author of this article at: jpafiti@pomlaw.com

Why Bother To Investigate Before Bringing A Derivative Action?

Attorney: Gabriel Henriquez
Pomerantz Monitor July/August 2016

State law allows shareholders to bring derivative actions, under certain circumstances, seeking recovery on behalf of their corporations. Usually those cases allege that the directors of the corporation have breached their fiduciary duties to the company. Typically the directors, not shareholders, have the responsibility of deciding whether to bring such cases. Shareholders can “demand” that directors bring such a case, but if they do that, and the directors refuse, it is next to impossible for shareholders to pursue their case. But there are exceptions to this “demand” requirement in cases where plaintiffs can show that demand would be “futile.”

Although one might assume that it would always be “futile” to demand that directors sue themselves, the law does not start with that assumption. To the contrary, Delaware courts, for example, require that plaintiffs plead specific facts establishing, in essence, that it is likely that the directors have done something wrong, justifying bringing an action against them. “Conclusory,” non-specific allegations are not enough. Unless shareholders have access to inside information from the company, it is often difficult to satisfy this standard; and courts have dismissed such cases with depressing regularity.

About 20 years ago, the Delaware Supreme Court started suggesting, in its opinions affirming dismissal of such cases, that the result might have been different if the shareholders had only done a better investigation of the facts before bringing the action. In particular, it pointed to Section 220 of the Delaware Corporation Act, which allows shareholders of Delaware corporations, before bringing a lawsuit, to demand the right to inspect the books and records of the corporation concerning potentially dubious transactions. Such inspections, the court noted, are the “tools at hand” that could in many cases provide the specific facts necessary to establish demand futility and allow a derivative case to go forward. The Delaware Chancery Court has exclusive jurisdiction to grant relief under Section 220.

But this prescription ignores the practicalities of derivative litigation. News of potential corporate wrongdoing typically leads to multiple lawsuits brought by shareholders, sometimes in different states. Because there is no law requiring that investors bring a books and records proceeding before filing a derivative case, some of these cases will be filed without a pre-filing inspection and they will proceed quickly, while shareholders who do file a books and records demand are still waiting for a resolution of that proceeding.

If all the relevant proceedings are brought in the same jurisdiction, such as Delaware, the courts will often stay the quick-filing cases to allow the books and records plaintiffs to catch up. But what happens if the first filed cases are brought out of state, are not stayed, and are dismissed on “demand futility” grounds before the books and records plaintiffs have had a chance to build their case?

Two recent opinions from Delaware’s Court of Chancery are likely to change the ground rules in such situations.

In cases involving Lululemon and Wal-Mart, plaintiffs who had not availed themselves of Section 220 filed “conclusory” complaints outside of Delaware that were dismissed for failure to make demand on the directors to bring an action. At the same time, two different sets of plaintiffs completed their books and records inspections and then filed their respective derivative complaints in Delaware. Because the Section 220 actions took several years to complete, by the time these investors were able to bring their actions, the other, out of state derivative cases had already been dismissed. With the benefit of their inspection of corporate records, the complaints in the Delaware actions were far more specific and detailed than the out of state complaints had been.

Nevertheless, the Chancery Court dismissed the Delaware derivative lawsuits because it found that the courts in the non-Delaware proceedings had already decided that demand on the directors to bring these claims was not excused. As a result, the Delaware plaintiffs gained nothing from their years’-long efforts to investigate the case by using Section 220.

In Lululemon, the company’s founder was accused of insider trading after unloading a bulk of his shares the day after finding out that the company’s CEO intended to resign, but before that information was released to the public. In order to investigate diligently, one of the shareholder plaintiffs, represented by Pomerantz, filed a Section 220 action demanding corporate records from Lululemon in May 2013. Another Section 220 action was brought by another shareholder plaintiff in Delaware in October later that year. On April 2, 2014, the Chancery Court ordered Lululemon to produce documents relating to the sale of shares that occurred just before the public announcement of the CEO’s resignation. In July 2015, the Delaware plaintiffs filed their derivative lawsuit against Lululemon for breaches of fiduciary duties.

The first derivative lawsuits against Lululemon alleging breaches of fiduciary duties were filed in New York federal court after Pomerantz filed its Section 220 action in Delaware. Separate New York suits by two shareholder plaintiffs were filed in August 2013, but an amended complaint consolidating the two was filed January 17, 2014. In response to the New York case, Lululemon filed a motion to dismiss, arguing that the New York plaintiffs failed to adequately allege demand futility. Pomerantz, on behalf of the Delaware plaintiffs, sought to intervene in the New York matter, requesting that the New York court stay the case pending resolution of the Section 220 action in Delaware, or in the alternative, to dismiss one of the breach of fiduciary duty claims without prejudice in order to allow it to move forward in Delaware.

The New York federal court denied Pomerantz’s requests and granted defendant’s motion to dismiss. Shortly thereafter, the Chancery Court in Delaware dismissed the Delaware derivative complaint, finding that the same claims and issues had already been adjudicated in New York.

The Lululemon decision comes on the heels of the Wal-Mart decision, rendered two months before, where diligent plaintiffs in Delaware got the short end of the stick following the dismissal of an analogous but poorly researched case in an Arkansas federal court. In 2012, a widely-publicized bribery scandal led shareholder plaintiffs to file lawsuits against Wal-Mart. In Delaware, the plaintiffs first filed a Section 220 action that took three years to resolve. They did not file their derivative action until July 2015. The Arkansas plaintiffs filed their derivative action without the benefit of making a books and records demand. Much like in Lululemon, Wal-Mart filed a motion to dismiss attacking the Arkansas plaintiffs’ failure to allege demand futility with sufficient facts. The Arkansas federal court agreed with Wal-Mart and dismissed the complaint; shortly thereafter, the Delaware Chancery Court dismissed its derivative complaint on the grounds of issue preclusion.

Key to both decisions was the finding that there is no presumption of inadequacy for fast-filing plaintiffs, and that the level of detail between the competing complaints is irrelevant to the issue preclusion analysis. In other words, diligent plaintiffs who sought books and records before suing are stuck with the results of the quick-filing cases.

At the time, the distinctive circumstances of the Wal-Mart case tempered arguments in favor of de-emphasizing Section 220 actions. Indeed, rarely do Section 220 actions drag on for three years. However, coupled with the Lululemon decision, plaintiffs faced with the prospect of multi-jurisdiction litigation need to analyze the practical benefits of filing an action quickly rather than waiting for a books and records action to conclude—even if the former goes against the advice of the Chancery Court to make use of the “tools at hand.”

The Supreme Court Allows Investors To Pursue State Law Claims In State Court

Attorney: Justin Nematzadeh
Pomerantz Monitor July/August 2016

Federal courts have exclusive jurisdiction over claims alleging violations of the Securities Exchange Act, such as securities fraud. But in some cases the same conduct can violate both the federal securities laws and state laws; and in some of those cases investors may choose, for a variety of tactical reasons, to bring their claims in state court, under state law only. Naturally, defendants look for ways to fight back. In class action cases, Congress passed a law a few years ago that effectively federalizes all state law cases challenging conduct that could have been pleaded as securities laws violations, whether investors pleaded federal claims or not. But that leaves open the question of when and whether claims brought by individual investors can proceed in state court.

In a case involving Merrill Lynch, the United States Supreme Court recently answered that question. It held that a state law case does not have to be brought in federal court just because defendants’ alleged conduct could also be a violation of the Securities Exchange Act.

In that case, former shareholders of Escala Group, Inc. sued Merrill Lynch and several other financial institutions for manipulating the price of Escala stock through “naked short sales” of its stock. In a typical short sale, the seller borrows stock from a broker, sells it to a buyer on the open market, and later purchases the same number of shares to return to the broker. The short seller pockets the potential stock price decline between the time of selling the borrowed shares and buying the replacement shares to pay back the broker’s loan.

But in a naked short sale, the seller has not borrowed the stock that he is selling short. In market manipulation cases, for example, defendants typically flood the market with a large number of sell orders, but it may not be possible to borrow enough shares to cover all these transactions. In those cases, the short seller may not be able to deliver the sold shares to the buyer when the transaction is scheduled to close. Naked short selling can drive down a company’s stock price, injuring investors. SEC regulations aim to curb market manipulation by prohibiting short sellers from intentionally failing to deliver securities.

In the Merrill Lynch case, plaintiffs sued defendants in New Jersey state court for naked short selling under several New Jersey statutes and common law causes of action. Although not alleging violations of the federal securities laws, the complaint catalogued past accusations against defendants for flouting securities regulations, couching the naked short-selling description in terms suggesting that defendants had again violated this regulation.

Defendants attempted to remove the case to federal court, plaintiffs objected, and the ensuing struggle played out all the way to the Supreme Court. There defendants argued that plaintiffs had explicitly or implicitly asserted that defendants had breached an Exchange Act duty, so the suit was “brought to enforce” that duty and gave federal court exclusive jurisdiction. Under this argument, the case would have remained in federal court even if plaintiffs had sought relief only under state law and could have prevailed without proving a breach of an Exchange Act duty. Plaintiffs countered by arguing that a suit is “brought to enforce” the Exchange Act’s duties only if the asserted causes of action were created by the Exchange Act, which was not the case here.

The Supreme Court adopted a middle ground, ultimately siding with plaintiffs and remanding the suit to state court. Adopting a “natural reading” of the exclusive jurisdiction provision, the Court held that it did not apply just because a complaint mentions a duty established by the Exchange Act. The Supreme Court held that exclusive federal jurisdiction applied only when a complaint (i) directly asserted an Exchange Act cause of action or (ii) asserted a state law cause of action that would require the plaintiff to demonstrate that defendants breached an Exchange Act duty. Plaintiffs’ suit would have fallen under the compass of the second prong of this interpretation if the New Jersey statutes made illegal “any violation of the Exchange Act involving naked short selling.”

Noting respect for state courts, the Supreme Court stated that its decisions reflected a “deeply felt and traditional reluctance . . . to expand the jurisdiction of federal courts through a broad reading of jurisdictional statutes.” Deference to state courts was stronger here to limit Section 27 of the Exchange Act’s mandated—rather than permitted— federal jurisdiction, depriving state courts of all ability to adjudicate claims. The Supreme Court stated that Congress likely contemplated that some complaints intermingling state and federal questions would be brought in state court by specifically affirming the capacity of state courts to adjudicate state law securities actions. Moreover, the exclusive jurisdiction provision does nothing to prevent state courts from resolving Exchange Act questions resulting from defenses or counterclaims.

After Merrill Lynch investors can avail themselves of the additional weapon of state court in suing for market manipulation by asserting causes of action under state laws that do not necessitate a showing of a federal-law breach. In doing so, they can even allege defendants’ federal-law violations for similar conduct.

Court Grants Final Approval Of $45 Million Groupon Settlement

Pomerantz Monitor July/August 2016

The Honorable Charles R. Norgle of the United States District Court for the Northern District of Illinois has granted final approval of the $45 million class settlement achieved in In re Groupon Securities Litigation, No 12 C 2450 (N.D. Ill.). The Pomerantz Firm was appointed lead counsel in 2012, and has vigorously litigated the case for nearly four years.“We are pleased to have reached this favorable settlement for class members,” Pomerantz partner Joshua Silverman stated.

The Pomerantz Firm reminds all investors who purchased shares in Groupon’s initial public offering, or between November 4, 2011 and March 30, 2012, that the Court has established a claims filing deadline of August 26, 2016.

Claims forms, class notice, and other important documents are available on the settlement website: www.grouponsecuritieslitigation.com.

Huge Appraisal Remedy Awarded In Dell Merger Case

Attorney: H. Adam Prussin
Pomerantz Monitor July/August 2016

In 2013, Michael Dell, the founder and CEO of computer manufacturer Dell, Inc., offered to take the company private at a price of $13.75 per share. Many investors were dissatisfied with the offer, but it was approved by a majority vote of the shareholders.

Many shareholders who voted against the deal elected to pursue an appraisal remedy, which allows dissenters to ask the court to determine the “fair value” of their shares. Appraisal petitions are representative actions brought on behalf of all investors pursuing appraisal, meaning only one dissenting shareholder needs to file a petition and prosecute the appraisal case on behalf of others. An appraisal differs significantly from typical shareholder lawsuits challenging mergers. Most notably, they don’t involve claims of wrongdoing. It is not necessary, for example, to show that the directors who negotiated and approved the transaction were conflicted, were negligent, or in some other way breached their fiduciary duties to investors. In fact, in the Dell case the court determined that no such violation had occurred and that the directors did everything they could to seek competitive bids for the company. Here, no competing bidder could be found who could challenge Michael Dell’s bid.

Nevertheless, dozens of shareholders were convinced that the price Dell paid was not “fair value,” as defined by Delaware law, and sought appraisal of their shares. Several of them were declared ineligible to pursue this remedy because they had failed, for one reason or another, to comply with Delaware’s byzantine rules for pursuing appraisal. In the end, 20 institutional investors were allowed to pursue their claims.

This spring, the Delaware Chancery Court issued a bombshell ruling in the appraisal case, finding that the “fair value” of Dell’s shares was $17.62 each, about 22 percent above the merger price of $13.75. Put another way, the court found that the $22.9 billion paid in the merger undervalued the company by about $6 billion. However, because only 20 investors were deemed qualified to pursue their appraisal remedy, they will get only about $35 million as a result of the decision, leaving almost $6 billion “on the table.”

Embarrassingly, among the disqualified shareholders were clients of T. Rowe Price, a mutual fund manager that had vociferously opposed the merger. Price accidently voted its clients’ shares in favor of the transaction and thereby disqualified them from pursuing an appraisal remedy. As an act of contrition Price reimbursed its clients $194 million – a pretty costly mistake.

The Dell appraisal decision may well add fuel to a recent upsurge in appraisal cases resulting from going private mergers. Increasingly, hedge funds and other aggressive investors have been snatching up shares of companies that are the subject of a takeover or going private proposals, in the expectation that they will file an appraisal case and make a killing in the transaction. From January 2015 to date, appraisal petitions were filed in about 15% of transactions eligible for appraisal. The results in these cases have been pretty good: an article in a trade journal, Securities Law 360, surveyed appraisal cases during the past 6 years, and found that the courts awarded large judgments to investors, above the merger price, much of the time. For example, in the Dole Food deal, it awarded a 20% premium; In the Safeway deal, 26%; Canon, 17.6%; Hesco, 75.5%; Orchard Enterprises, 127.8%; 3M Cogent, 8.5%; Cox Radio, 19.8%; Am. Commercial Lines, 15.6%; Golden Telecom, 19.5%; and Sunbelt Beverage, 148.8%. On top of these large premiums, the courts also awarded hefty interest on these awards. The appraisal statute requires the court to award interest on the award at a relatively high rate.


POMTalk: Defined Benefit Plans Truly Benefit Public Employees


As I visit institutional investor clients across America, a frequent topic of discussion is a cost/benefit analysis of defined benefit vs. defined contribution plans. As I will more fully explain below, research and experience have demonstrated that public pension funds and the employees they serve likely do best contributing to a defined benefit plan coupled with a portfolio monitoring service.

Most state, municipal, and county workers are covered by a traditional defined benefit plan.

The financial crisis of 2008 and its aftermath led some public pension funds to consider shifting some or all of their pension systems from a defined benefit to a defined contribution plan. In fact, six states have replaced their traditional defined benefit plan with a mandatory hybrid plan (which requires participation in both a defined benefit and a defined contribution plan): Georgia, Michigan, Rhode Island, Utah, Tennessee, and Virginia.

Prior to the financial crisis, while feeling the glow of the stock market’s stellar performance of the 1990’s, Michigan and Alaska introduced plans requiring all new hires to participate solely in a defined contribution plan. Meanwhile, California, Indiana, and Oregon adopted hybrid plans. Colorado and Ohio have introduced optional defined contribution plans. Enrollment in these plans has been modest, with most workers choosing to continue to maintain the protection against investment risk and the promise of an annuity that defined benefit plans offer. In Alaska, however, despite the fact that nearly three quarters of its public employees are not covered by Social Security, all new hires are required to join a defined contribution plan. The result is that Alaskan state workers and teachers hired since July 2006 do not have any form of defined benefit protection.

According to a 2014 study by Alicia H. Munnell, Jean-Pierre Aubry, and Mark Cafarelli of the Center for Retirement Research of Boston College, what motivated states to introduce a defined contribution plan differed before and after the financial crisis. Before 2008, some saw it as a way to offer employees an opportunity to manage their own money and participate directly in a rapidly rising stock market. In contrast, after the financial crisis, cost and risk factors motivated some states to make the shift.

A 2016 study by Nari Rhee and William B. Fornia of the University of California, Berkeley, modeled how retirement income would fare for teachers on three types of pension: (1) the current defined benefit offering from the $186 billion California State Teachers Retirement System (“CalSTRS”) for hires since 2013; (2) an idealized 409(k) plan (similar to defined contribution); and (3) a cash balance plan with guaranteed 7% interest on contribution. The result, in a nutshell: for the vast majority of California teachers (six out of seven), the CalSTRS defined benefit pension provided greater, more secure retirement income compared to a 401(k)-style plan.

Apart from the rewards of defined benefit plans touted by numerous studies, a significant benefit available to these plans—that is not available to defined contribution plans -- is that their investment portfolios may be monitored by professionals who are expert in identifying and evaluating losses attributable to financial misconduct, and providing advice to institutional investors on how best to maximize their potential recoveries worldwide. The United States sees hundreds of new securities fraud class actions filed each year, as well as approximately 100 class action settlements. Institutional investors that do not engage a portfolio monitoring service run the risk of leaving money on the table by not participating in settlement recoveries or taking affirmative action to recover their losses when appropriate.

Public pension funds that offer a defined benefit plan coupled with a portfolio monitoring service get top marks for ensuring that their employees will enjoy a secure and amply funded retirement. 



CFPB Proposes Rule to Override Arbitration Clauses in Contracts for Financial Transactions.

As the Monitor has reported, the Supreme Court opened the door recently to allowing companies to enforce arbitration clauses in contracts with their customers, which would bar class actions. Because most consumer claims are too small to warrant prosecution on an individual basis, this tactic has the potential to insulate these companies from any avenue of redress.

On May 5, the Consumer Financial Protection Bureau issued a proposed rule that would restore customers’ rights to bring class actions against financial firms. The rule would apply to bank accounts, credit cards and other types of consumer loans. As reported in the Times, the new rules would mean that lenders could not force people to agree to mandatory arbitration clauses that bar class actions when those customers sign up for financial products. The changes would not apply to existing accounts, though consumers would be free to pay off their old loans and open new accounts that are covered. The rule would apply only to the consumer financial companies that the agency regulates. It would not apply to arbitration clauses tucked into contracts for cellphone service, car rentals, nursing homes or employment.

The rules are not subject to Congressional approval.

Labor Department Issues Rule Imposing Fiduciary Duty on Brokers Who Advise Clients Investing in Retirement Products or Accounts.

Acting under authority conferred by ERISA, the Labor Department has finally issued a rule requiring brokers who give retirement advice to clients to enter into contracts with them affirming that they have a duty to recommend transactions only when they are in the client’s best interest. The current rule requires only that the investments they recommend be “suitable” for the clients, leaving room for brokers to recommend investments that generate the biggest fees for themselves, rather than those that are best for their customers.

For years the financial services industry has warned that this rule change would impose an enormous burden on them and on investors as well, whose costs (they say) would increase. But, as Senator Elizabeth Warren pointed out recently in a letter to the SEC, some of the biggest objectors to the new rule have been telling their own shareholders that they have nothing to worry about if the fiduciary rule is adopted. That is like trying to have your cake and eating it too.

Warren sent her letter to the SEC because that agency has so far failed in its obligation to revise these rules for regular, non-retirement brokerage accounts and other advisory relationships, even though the Dodd Frank Act requires the agency to do so.

 Agencies Try To Rein In Executive Compensation.

In April the National Credit Union Administration unveiled its proposal to implement a provision of the Dodd-Frank Act by requiring that incentive compensation that top financial executives receive gets deferred for several years and that  firms put in clawback provisions so they can take back bonuses paid to executives responsible for significant losses or illegal actions.

The Dodd-Frank Act charged the NCUA, the Federal Reserve, the Federal Deposit Insurance Corp., the Federal Housing Finance Agency, the Office of the Comptroller of the Currency, and the U.S. Securities and Exchange Commission with writing rules or guidance that would restrict bonus and other incentive compensation for financial executives, in a bid to limit the temptation to take on excessive risk. Some of these other agencies, at least, are expected to echo the NCUA’s proposal.

U.S. financial regulators set up three different tiers for implementing rules, with executives at firms with $250 billion in assets facing the toughest restrictions, followed by those at firms with assets between $50 billion and $250 billion. Firms that have between $1 billion and $50 billion will be required to put in place risk-management, record-keeping and other monitoring tools.

 Nastiest Case in Delaware.

The Delaware courts, which handle serious matters of corporate governance, are well known for their decorum and high mindedness. But the Delaware Supreme Court is currently mulling the appeal in one of the nastiest, tackiest cases to hit that state in a long time. Alan Morelli, the former chairman of OptimisCorp., a California based healthcare company, is suing the directors who abruptly terminated him in 2012, after receiving accusations that Morelli had sexual relations with an employee and also sexually harassed her. Three of those directors filed their own action against the executive, claiming that in retaliation for their dismissal of him he launched a legal vendetta against them, using $12 million of company funds. After a six day trial last year, the Chancery Court dismissed Morelli’s claims against the directors, concluding that they were unproven. The vice chancellor added that his decision also reflected a sanction against Morelli for paying or threatening witnesses with criminal prosecution or civil action “based on questionable or baseless claims.” One female therapist who accused Morelli of sexual harassment later withdrew the claim, after receiving a promise of a $550,000 series of payments in exchange for her testimony.

During the argument of the appeal, Supreme Court Justice Strine asked whether Optimis is “one of the weirder companies that exists in the world,” observing that “one of the officers of the company was having a relationship with

Mr. Morelli’s ex-wife,” while Morelli, whose office was in his bedroom, was having relations with the employee who subsequently accused Morelli of harassment.

Eighth Circuit Makes it Too Easy to Rebut Presumption of Reliance


In a case called Halliburton II, the Supreme Court reaffirmed the validity of the presumption of reliance under the  fraud on the market theory,” which is critical to securities plaintiffs’ ability to show class-wide reliance on a company’s misstatements. But it also held that a defendant may rebut the presumption of reliance by showing that the alleged misstatements had no “price impact,” i.e. did not affect the price of the stock in question. Under Fed. R. Evid. 301, “the party against whom a presumption is directed has the burden of producing evidence to rebut the presumption,” but the rule does not specify how much evidence must be produced, and Halliburton II did not shed any light on this issue, either. This raises the question: how much evidence is enough to rebut the presumption? Is any showing enough?

In Best Buy, the Eighth Circuit recently handed down the first federal appellate decision to attempt to answer those questions. It is widely accepted that price impact may be proven by evidence showing that either the price increased after an alleged misstatement or that the price decreased after the truth was revealed. In Best Buy, plaintiffs met one but not both of these elements. Specifically, plaintiffs challenged three statements the company made on September 14, 2010. First, it issued an early morning earnings release saying that it was increasing its EPS guidance by ten cents. In response, the stock price opened for trading at a price higher than the previous day’s close. The next two statements were made later that morning in a conference call with analysts, when the CEO and CFO stated that the company’s earnings were “essentially in line with our original expectations for the year” and that it was “on track to deliver and exceed our annual EPS guidance.” The stock price did not increase after the conference call statements. The allegedly corrective disclosure occurred on December 14, 2010, when Best Buy announced a decline in its fiscal third quarter sales and a reduction in its 2011 fiscal year EPS guidance, causing a 15% stock price drop.

In an earlier decision, the district court held that the first misstatement, the early morning earnings release, was not actionable because it was a “forward-looking statement” with appropriate “cautionary language,” and was therefore covered by an Exchange Act “safe harbor” provision. The other two misstatements survived that motion and were the focus of the class certification motion, where defendants claimed that the misstatements did not move the market and that the presumption of class-wide reliance had therefore been rebutted.

In support of its class certification motion, plaintiffs submitted an expert report saying that Best Buy’s stock price had increased in reaction to all three September 14th statements, but did not parse how much of the increase was attributable to each individual statement. Defendants’ expert report said that there was no price impact from the conference call statements because the stock price increased only after the earlier morning press release, and not after the conference call occurred several hours later. In reply, plaintiff’s expert conceded that the conference call statements did not cause an immediate stock price increase, because it essentially just confirmed the representations in the previous early morning release. However, he said that the false statements that came afterwards maintained the artificially inflated price caused by that release.

The district court certified the class, recognizing that price impact (and therefore reliance) can be shown by a price decline in response to a corrective disclosure, and that defendants had failed to make any showing that Best Buy’s stock price did not in fact decrease after the negative news released on December 14th. The district court also found that the alleged misrepresentations could have prolonged the inflation of the price, or slowed the rate of fall, satisfying the “price maintenance” theory of “price impact.”

The Eighth Circuit reversed, pouncing on plaintiffs’ expert’s concession that the conference call statements did not move the stock price, and found that this was “strong evidence” sufficient to negate price impact and therefore class- wide reliance. The majority flatly rejected plaintiffs’ additional contention that the conference call statements caused a gradual increase in the stock price between September and December as “contrary to the efficient market hypothesis.” And the court largely ignored plaintiffs’ additional evidence of price impact, shown by the stock price decline after the corrective disclosure.

This decision is troublesome for several reasons.  Courts have generally found a presumption of reliance exists when shareholders show stock prices fell in response to a corrective disclosure. The Eighth Circuit did not follow that principle, focusing instead only on the front end of the supposed fraud, when misstatements had no obvious impact on the share price. The Eighth Circuit also explicitly rejected the price maintenance theory, which has been heavily relied upon by plaintiffs seeking to prove price impact where misstatements did not move the price of a company’s stock.

A decidedly pro-defendant decision, Best Buy shows that defendants facing securities fraud class actions can significantly narrow or eliminate liability during the class certification phase based on price impact arguments. If followed by other circuits, the decision could have significant negative consequences for securities actions, because false positive statements by a company often have little or no immediate impact on the company’s stock price.

Court Denies Motion to Dismiss Our Staar Surgical Complaint


Judge Fitzgerald of the Central District of California recently denied defendants’ motion to dismiss our action involving STAAR Surgical Company. The action alleges that the company, its CEO and its vice president of regulatory affairs violated section 10(b) of the Securities Exchange Act as well as section 20(a), the “control person” provision.

STAAR is an FDA regulated company that designs, manufactures and sells implantable lenses to correct vision problems. In March of 2014, the company told investors that it believed that it was in compliance with all applicable FDA regulations despite the fact that an FDA inspection of STAAR’s plant was ongoing at the time and the inspector had repeatedly told management that numerous and significant FDA violations had been found. These violations are particularly important to STAAR and its investors because STAAR had a major new lens that was going before the FDA Advisory Panel in mid-March, and these violations would likely delay its approval. The company did not disclose these reports of violations, and investors did not hear about them until the FDA posted them on its website months later. At that point, STAAR’s stock price plunged 17.5%

 Defendants’ main argument for dismissal was that at the time they made their representations of compliance the violation reports were only preliminary and had not been formalized in written notices. The court rejected that argument, holding that because the FDA inspector had repeatedly identified the violations orally to management, defendants would have known that their statements of compliance would mislead investors. The court also held that the company had a duty to disclose the subsequent Warning Letter from the FDA, which stated that the new lens would not be approved by the FDA until the violations were remedied. The court held that, even though the company did not make any further “compliance” representations when it received the Warning Letter, it nevertheless had a duty to correct its prior statement on that subject.

 This opinion is significant because it shows that a statement of compliance can be misleading as a result of the FDA inspector orally identifying violations. Prior cases had dealt with the company having receipt of a written notice of violation or Warning Letter.

New York Adopts Delaware Standards for Going Private Mergers


In a case called the Kenneth Cole Shareholder Litigation, the New York Court of Appeals adopted, as the rule in New York, the MFW decision of the Delaware Supreme Court. There, the Delaware court held that, for claims seeking damages, the business judgement rule can protect the decision of a board of directors to accept a going private merger if certain conditions are met. Ordinarily, such decisions are reviewed under the “entire fairness” test, a very pro-plaintiff standard. The MFW court held that the business judgment rule can apply instead, provided that a series of shareholder protections exist: the merger was approved by both a special committee of independent directors and a majority of the minority shareholders; the special committee was independent and was free to reject the offer and to hire its own advisers; and the vote of the minority was informed and uncoerced. To survive a motion to dismiss, the complaint must allege facts showing that the transaction lacked one or more of these shareholder protections.

Meanwhile, the Delaware Supreme Court has itself recently extended the MFW decision to apply also to director decisions to approve mergers with unrelated entities. In such cases, where the complaint seeks damages, the entire fairness rule is inapplicable, but the courts have typically applied an intermediate standard of review, called enhanced scrutiny.” In a case called KKR, the court has now held that if the MFW conditions are met, the business judgment rule protects such decisions in post-closing actions as well. It added that under those circumstances, a showing of “gross negligence” by the directors is not sufficient to rebut the protection of the rule; “waste” has to be shown, which is an almost insurmountable burden.

Supremes: Statistical Averages Can Provide a Basis for Class-Wide Liability


In Tyson Foods v. Bouaphakeo, the Supreme Court upheld the use of statistical sampling evidence in class actions, at least where such evidence would have been admissible in an individual action. Defendants had argued that such statistical methods improperly treated each individual as if he or she matched a statistical average, thus manufacturing predominance by assuming away the very individualized differences that made class-wide litigation inappropriate in the first place. The Court rejected this premise and focused instead on the relevance of the statistical evidence to the substantive claim at issue. It held that, if a given class member could have used the statistical evidence to obtain a favorable jury verdict in an individual action, then the class could use it the same way. It was up to the jury to decide, in light of all of the evidence presented, whether the statistical average was probative of the situation of each class member.

Particularly under the specific facts of the case, this ruling was a straightforward application of evidentiary common sense. Nevertheless, it was generally seen as a significant victory for the plaintiffs’ bar.

The case involved workers at a pork processing plant who claimed they were not paid overtime for time spent putting on and taking off protective gear, in violation of federal law requiring compensation for such “donning and doffing”  time if it is “integral and indispensable” to their regular work. After the district court certified two classes of employees, the case went to trial and the jury awarded the classes $29 million in damages. On appeal, the defendant argued that the verdict should be thrown out because the classes never should have been certified.

To be certified as a class, the worker-plaintiffs had to prove that they could establish key elements of their claims through generalized, class-wide proof. This was easy for some elements: they all worked in the same plant, had similar job responsibilities, and were subject to essentially the same compensation policies. But the defendant insisted that individualized inquiries into each employee’s total donning and doffing time were necessary because different employees wore different gear and took varying amounts of time to don and doff the gear. It also argued that no class could be certified without proof that every member was injured, which required individualized inquiries into each employee’s time.

Federal law, to some degree anticipating this evidentiary problem, has long required employers to keep accurate records of employee work hours. But despite a 1998 federal court injunction against the very same slaughterhouse requiring it to record employee time donning and doffing protective gear, Tyson Foods had never done so. Instead, it had been compensating workers based on its own approximations of how long those activities should take.

Because there was no good individualized evidence, the worker-plaintiffs used what they called “representative evidence” to show how long workers in each department generally took to don and doff protective gear. Most significantly, they presented a study by an industrial relations expert who drew on a representative sample of 774 videotaped observations of workers and calculated the average time for workers in each department to don and doff their gear.

There are procedural mechanisms to ensure the reliability of this kind of evidence, but the defendant largely ignored them. It did not challenge the expert’s qualifications or statistical methodology. It rejected the workers’ proposal to bifurcate the trial into separate proceedings for liability and damages. While it argued at trial that the expert’s calculations were too high, it did not present a rebuttal expert with different calculations. Instead, in opposing class certification and also at trial, it insisted that it was fundamentally improper to assume that each employee donned and doffed for the same time as the average in the sample. It decried being subjected to a “trial by formula” and barred from raising unspecified “defenses to individualized claims.” And on appeal, it called for a categorical rule barring the use of representative sampling evidence in class actions.

The Supreme Court rebuffed this effort and categorically rejected the idea that class actions required their own special set of evidentiary rules. It emphasized that statistical sampling evidence is routinely used in all kinds of litigation and is often the only practicable means, for plaintiffs and defendants in individual as well as class actions, to collect and present relevant data. Thus, it held that class certification was proper as long as a reasonable jury could have believed that the employees spent roughly equal time donning and doffing. If so, it was for a trial jury to weigh the expert’s average-time calculations against the other evidence presented and to decide whether the statistical average was probative of the time actually worked by each employee.

While the utility of statistical averages in other class actions will vary, the main takeaway is that the issue must be considered in practical terms of how a reasonable jury resolving the underlying substantive claim would view the evidence. In many cases, statistical averages will be the most compelling evidence available and will say a great deal about each member of the class. This was particularly true in Tyson Foods because the defendant had never bothered to keep individualized records (despite being legally mandated to do so), and instead simply paid workers based on its own approximations of how long donning and doffing should take. But in other cases with stronger evidence of meaningful individualized variations, a jury might find statistical averages less useful.

Our Control Person Claims Upheld In Magnachip

Attorney: Michael J. Wernke
Pomerantz Monitor March/April 2016

In this case, defendant Magnachip had been forced to restate its earnings drastically after its revenue recognition policies had been found wanting. We settled our claims against all the other defendants in the litigation, except for Avenue Capital Management, which was, at one point, Magnachip’s majority shareholder. We had sued ACM under the “controlling person” provisions of the securities laws.

The district court has now substantially denied ACM’s motion to dismiss our claims against it.

The Court rejected ACM’s argument that it did not control MagnaChip because it was a minority shareholder for much of the Class Period. The Court held as adequate to allege control that ACM was a majority shareholder when the alleged fraud began; its appointees continued to serve on the Board of Directors even after its holdings declined; it continued to have significant influence over MagnaChip’s affairs; and ACM used its control to cash out its investment in MagnaChip at enormous profits.

Loss Causation and Disclosures of Investigations

Attorney: J. Alexander Hood II
Pomerantz Monitor March/April 2016

In many instances, the first indication of securities fraud is an announcement that a company is under investigation by some government authority—for example, the SEC, the Department of Justice, a U.S. Attorney’s office, or a state attorney general, to name a few. Frequently these announcements are immediately followed by significant stock drops, as the market reacts to the fact of the investigation, even before the investigation’s findings are disclosed. Because the market has already reacted to the bad news, it sometimes fails to react to subsequent news of the investigation’s findings or to disclosure of false statements by the company that the government was investigating. This non-reaction often reflects the fact that investors assumed the worst when the investigation was first announced, and thus do not react a second time to what is, in some sense, the same news, when the fraud at issue is subsequently confirmed.

For plaintiffs in securities fraud lawsuits, however, the market’s failure to react to news confirming the fraud can be a problem. To survive a defendant’s motion to dismiss, the complaint must show that the investor’s economic loss was caused by the revelation of the defendant’s fraud. Thus, when a company’s stock price plummets in reaction to news of an investigation and then barely moves when the fraud is subsequently confirmed, the company may argue that the only loss was caused by the announcement of an investigation, which the company would characterize as an intervening event, and that no losses were directly traceable to disclosure of news of the fraud itself.

Addressing these issues in Jacksonville Pension Fund v. CVB Financial Corporation, the Ninth Circuit Court of Appeals presented a sensible, context-specific view ofloss causation, holding that the announcement of an SEC investigation related to an alleged misrepresentation, coupled with a subsequent revelation of the inaccuracy of that representation, can serve as a corrective disclosure for the purposes of loss causation—in other words, that under such circumstances, the losses caused by the announcement of the investigation are recoverable, even if the stock fails to react to the subsequent confirmation of the fraud.

In 2008, CVB Financial Corporation was informed by the Garrett Group, a commercial real estate company that was CVB’s largest borrower, that Garrett would be unable to make payments on its loans from CVB. After the loans were restructured, Garrett again informed CVB in 2010 that it could not make the required payments and was contemplating bankruptcy. Nonetheless, in 2009 and 2010 SEC filings, CVB represented that  there was no basis for “serious doubt” about Garrett’s ability to repay its borrowings.

In 2010, the SEC served a subpoena on CVB, seeking information about the company’s loan underwriting methodology and allowance for credit losses. The day after CVB announced receipt of the SEC subpoena, the company’s stock dropped 22%, from $10.30 to $8.0 0per share, a loss of $245 million in market capitalization.

Analysts noted the probable relationship between the subpoena and CVB’s loans to Garrett. A month later, CVB announced that Garrett was unable to pay its loans as scheduled, wrote down $34 million in loans to Garrett, and placed the remaining $48 million in its non-performing category. On this news, however, the market barely reacted, and CVB’s stock price did not significantly fall.

As lead plaintiff in a consolidated action on behalf of CVB investors, Jacksonville Police & Fire Pension Fund filed a complaint in U.S. District Court for the Central District of California, alleging securities fraud by CVB and certain of its officers. However, the district court granted CVB’s motion to dismiss, holding that Jacksonville had failed to plausibly allege that the statements caused a loss to shareholders, given the market’s failure to react to CVB’s announcement that Garrett would be unable to pay its loans as scheduled.

On appeal, the Ninth Circuit reversed the district court’s decision on the loss causation issue. It agreed with the district court that the only significant fall in CVB’s share price occurred after the announcement of the SEC subpoena, and not after the disclosure that Garrett had failed to repay its loan. It noted that “the announcement of an investigation, standing alone and without any subsequent disclosure of actual wrongdoing, does not reveal to the market the pertinent truth of anything, and therefore does not qualify as a corrective disclosure.” However, the court held that in the case against CVB, the announcement of the SEC investigation did not stand alone; rather, the announcement was followed a month later by the company’s announcement that it was charging off millions in its Garrett loans. The market did not react to the subsequent news about the Garrett loans because the announcement of the SEC investigation foreshadowed the ultimate result. Commenting on the practical effects of its ruling, the Ninth Circuit observed that “any other rule would allow a defendant to escape liability by first announcing a government investigation and then waiting until the market reacted before revealing that prior representations under investigation were false.”

In short, the CVB Financial Corporation decision is a welcome and sensible development that removes a significant potential pleading obstacle to securities class actions in the Ninth Circuit.

Supremes: Rejected Offer Of Judgment Does Not Moot Claims Of Class Representative

Attorney: Louis C. Ludwig
Pomerantz Monitor March/April 2016

As we noted briefly in the last issue of the Monitor, in Campbell-Ewald Company v. Gomez, the Supreme Court ruled that a plaintiff’s claim cannot be mooted solely by an unaccepted settlement offer, including an offer of judgment pursuant to Federal Rule of Civil Procedure 68. Defendants had hoped that by offering the class representative – but not the class members – all the relief he or she had requested in the complaint, they could get rid of that representative and the class action as well.

The court’s ruling was widely seen on both sides of the bar as a victory for plaintiffs and their counsel. That reaction, however, was likely premature. Gomez leaves open the possibility that defendants could still “pick off” plaintiffs by actually paying or tendering them the amounts allegedly owed. Simply put, the “pick off” risk that bedeviled class action plaintiffs before Gomez remains at least theoretically intact in its wake.

Generally, Rule 68 allows a defendant to make an offer of judgment for a specified amount, including costs accrued   to date. If the plaintiff rejects the offer and the result obtained in the action is less than the amount of the rejected offer, the plaintiff must reimburse all of defendants’ costs incurred after the offer was made.

Turning down such an offer of judgment necessarily engenders risk, particularly for plaintiffs who choose to lead class actions, which, for various reasons, tend to incur higher costs on the path to trial. Even worse, defense lawyers have sharpened Rule 68 into a unique weapon known as the “pick-off” strategy,” which aims to quickly end potential class actions without ever getting to the merits of the claims.

The pick-off strategy typically plays out as follows: the named plaintiff in a class action is served with an offer of judgment for all the relief he or she personally seeks, separate from the class. Not wanting to sell out the class he or she represents, the named plaintiff rejects the Rule 68 offer in order to continue litigating for a favorable classwide outcome. Next, the defendant seeks the dismissal of the case on the basis that the offer provided the plaintiff with everything asked for in the complaint, leaving no “case or controversy” remaining to litigate. If that happens, the case cannot proceed on a class basis unless a new named plaintiff is willing to step forward. Even assuming that a new named plaintiff can readily be found, the successor is just as susceptible to the pick-off strategy as his or her predecessor.

Prior to Gomez, several federal appellate courts limited the pick-off strategy by making the effectiveness of a Rule 68 offer contingent on, variously, whether plaintiffs had been provided an opportunity to first file a motion for class certification or whether the offer actually preceded the filing of and/or ruling on a motion for class certification.

Gomez involved allegations of an unsolicited text message that violated the Telephone Consumer Protection Act (the “TCPA”). As a general matter, the TCPA places a $1,500 ceiling on statutory damages for a single violation. While Gomez was styled as a class action, the plaintiff, Gomez, had not filed a motion for class certification at the time defendant Campbell-Ewald (the advertising agency that sent the text message) served him with an offer of judgment for just over $1,500, plus reasonable costs. Gomez declined the offer by failing to accept it within the time provided. Subsequently, Campbell-Ewald prevailed on a motion for summary judgment on the ground that the offer of judgment mooted plaintiff’s individual claim.

The Court of Appeals for the Ninth Circuit reversed, holding, in part, that an unaccepted Rule 68 offer does not moot a plaintiff’s individual or class claims. As circuit precedent differed widely on these issues, certiorari was granted. The Supreme Court affirmed the Ninth Circuit, with the majority adopting Justice Elena Kagan’s dissent in Genesis HealthCare Corp. v. Symczyk, which reasoned that an “unaccepted settlement offer — like any unaccepted contract offer — is a legal nullity, with no operative effect.” The court concluded that the rejection could only mean that the settlement offer was no longer operative, and the parties “retained the same stake in the litigation they had at the outset.”

Nonetheless, the Gomez court’s focus on the offer-and acceptance dance of Contracts 101 led it to reserve, “for a case in which it is not hypothetical[,]” the question of whether defendants can continue to moot claims by making an actual payment of full relief. Justice Ruth Bader Ginsberg, writing for the majority, explained that a claim might be mooted under Rule 68 when a defendant “deposits the full amount of the plaintiff’s individual claim in an account payable to the plaintiff, and the court then enters judgment for the plaintiff in that amount.” Perhaps even more ominously, Chief Justice John Roberts described the majority’s “offers only”- circumscribed decision as “good news.”

With the recent passing of Justice Antonin Scalia and resultant 4-4 split on the Court, the possibility remains that defendants will try the tactic of full tenders of relief to named plaintiffs in class actions, and that the issue will likely find its way back to the High Court.

The securities plaintiff’s bar has not borne many such pickoff attempts, probably as an unintended consequence of the Private Securities Litigation Act of 1995 (“PSLRA”).

The PSLRA expressly creates an open competition for “lead plaintiff.” Although the investor with the largest losses usually wins that competition, it is only after a profusion of qualified plaintiffs has come forward following a nationwide notification process. Indeed, an entire informational infrastructure has arisen to provide investors with PSLRA-mandated notice of securities class actions. Moreover, unlike consumer class actions, where damages to individual class members may be relatively small, lead plaintiffs chosen in securities class actions typically hold hundreds of thousands or even millions of shares of company common stock, and have millions of dollars in individual damages. Thus, the act of picking off such plaintiffs would not only be extremely costly but would actually be futile owing to no shortage of potential replacements, and if it did work, it would result in thousands of individual shareholder claims being filed, swamping the courts. This would essentially amount to litigating thousands of shareholder claims on an individual basis. At least in the securities context, Gomez, a case about short-circuiting class actions, ironically ends up highlighting their economy, particularly from the vantage of the defendants’ bar. 


Executives Seeking To Avoid Securities Fraud Liability Must Plan Ahead

Attorney: Matthew L. Tuccillo
Pomerantz Monitor March/April 2016

A key element of any securities fraud claim is evidence of defendant’s scienter, or intent to defraud. One way to establish scienter is to show that a given defendant engaged in transactions (typically sales) in company securities during the alleged period of fraud. Indeed, a complaint that does not allege such transactions faces heightened scrutiny by the court on a motion to dismiss.

Executives trying to explain such transactions frequently point to the existence of a so-called Rule 10b5-1 stock trading plan, which, for example, could schedule automatic stock transactions at pre-determined intervals or at specific future times. Rule 10b5-1, enacted by the SEC in 2000, expressly states that a person’s transaction in a security is “not ‘on the basis of’ material nonpublic information” if it is demonstrated that “before becoming aware of the information, the person had…[a]dopted a written plan for trading securities.” See 17 C.F.R. 240.10b5 -1(c)(1)(i)(A)(3). Since then, the case law has strongly weighed in favor of executives who had sold company stock, even at the height of an alleged fraud, where the sales were made pursuant to such a trading plan, often ruling that stock trades made pursuant to the plan could not evidence scienter. 

However, one dogfight in which we frequently engage revolves around the circumstances and timing of a Rule 10b5-1 plan’s creation. In our experience, too often, executives chose either to adopt a new Rule 10b5-1 plan or to amend a pre-existing Rule 10b5-1 plan during the period of alleged fraud, frequently causing an increase in sales of company stock at inflated prices before the fraud gets revealed and the stock price corrected by such revelation. The executives later seek to hide behind the existence of such a plan as exonerating evidence of their lack of intent to profit from an alleged fraud, while we typically argue that the timing of its adoption or amendment negates that argument.

An important battleground on this issue has been the Second Circuit, which encompasses the U.S. federal district courts in Connecticut, Vermont, and most significantly, New York. For context, according to a recent report prepared by Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse, the Second Circuit alone accounted for 50 of the 189 (26.5%) securities class action lawsuits filed in 2015. Historically, we have relied upon a collection of lower court decisions from within the Second Circuit that discounted reliance by company insiders on Rule 10b5-1 plans adopted or amended during an alleged period of fraud. Included among them is George v. China Auto Sys., Inc., No. 11 Civ. 7533 (KBF), 2012 WL 3205062, at *9 (S.D.N.Y. Aug. 8, 2012), in which Pomerantz secured a ruling that Rule 10b5-1 trading plans entered into during the alleged period of fraud did not dispel the inference of the defendant executive’s scienter. Defendants, not surprisingly, have instead relied upon district court cases supporting the more generalized legal proposition that the existence of a Rule 10b5-1 plan undercuts the scienter inference, attempting to side-step the more nuanced factual issues surrounding the timing and circumstances of a plan’s adoption or amendment.

The Second Circuit Court of Appeals recently weighed in on this important issue, resolving it in favor of our  plaintiff side arguments in Employees’ Ret. Sys. of Gov’t of the Virgin Islands v. Blanford, 794 F.3d 297 (2d Cir. 2015).

Blanford concerned an alleged fraud regarding Green Mountain Coffee Roasters, Inc. and its Keurig brewing system, where investors were told that Green Mountain’s business was booming, with its inventory at “optimum levels” as it strained to meet high demand. In reality, it had been accumulating significant overstock of expiring and unsold product. During the alleged fraud, company insiders, including defendants Blanford (Green Mountain’s President/CEO/Director) and Rathke (its CFO/Secretary/Treasurer), sold company stock for millions of dollars in proceeds. Both Blanford and Rathke entered into new 10b5-1 trading plans just after one alleged misstatement (an earnings call), which permitted them to engage in significant sales shortly thereafter. The fraud was later revealed, causing Green Mountain’s stock price to plummet.

On these facts, the Second Circuit, citing Pomerantz’s decision in George v. China Auto Sys., among other precedent, rejected defendants’ argument that the 10b5-1 plan insulated them from an inference of scienter. Noting that Blanford and Rathke had entered into their 10b5-1 plans after an alleged misstatement (the earnings call) and after the fraudulent scheme began, the Second Circuit held: “When executives enter into a trading plan during the Class Period and the Complaint sufficiently alleges that the purpose of the plan was to take advantage of an inflated stock price, the plan provides no defense to scienter allegations.” Viewing the alleged facts holistically, the court held that defendants’ stock sales – including those made within the 10b5-1 plans – coupled with other alleged conduct (e.g., steps taken to conceal the true facts from investors), supported a strong inference of their scienter. Going forward, Blanford will be an important precedent, both in the Second Circuit and beyond, and we have already cited it to courts overseeing briefing on motions to dismiss our clients’ complaints.


Pomerantz Wins Class Certification In Two Major Cases: Barclays Investors Win Class Certification

Attorney: Tamar A. Weinrib
Pomerantz Monitor March/April 2016

The same day as the class cert ruling in Petrobras, February 2, 2016, Judge Scheindlin of the federal district court in the Southern District of New York, after a full evidentiary hearing, granted plaintiffs’ motion to certify a class of allegedly defrauded Barclays investors in the Strougo v. Barclays PLC securities litigation, and appointed Pomerantz as counsel for the class.

The case, which involves claims pursuant to Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, concerns defendants’ concealment of information and misleading statements over a three-year period regarding its management of its “LX” dark pool, a private trading platform where the size and price of the orders are not revealed to other participants. Even though the dark pool was just a tiny part of Barclays’ overall operations, Judge Scheindlin found that defendants’ fraud was highly material to investors because it reflected directly on the integrity of management. The court also found that reliance by class members on defendants’ omissions and misstatements could be presumed on a class-wide basis.

The court held that, under the Supreme Court’s Affiliated Ute doctrine, it was appropriate to presume that investors relied on the alleged material omissions, which involved defendants’ failure to disclose that they were operating their LX dark pool in a manner that did not protect Barclays’ clients’ best interests. Specifically, defendants failed to disclose that Barclays was not adequately protecting LX investors from “toxic” high frequency trading and were disproportionately routing trading orders back to LX. The court held that because LX constitutes a tiny fraction of Barclays’ business, a reasonable investor likely would have found the omitted misconduct far more material than the affirmative misstatements – because it reflected on management’s overall integrity. Indeed, it is for this reason that the court considered the omissions “the heart of this case.”


With respect to defendants’ affirmative misrepresentations, the court held that under the Supreme Court’s Basic “fraud on the market” doctrine, reliance by investors could also be presumed because Barclays’ stock trades in an efficient market. Its stock price would therefore have reflected defendants’ misrepresentations and omissions during the Class Period.

Of particular interest to Section 10(b) class action plaintiffs is the court’s rejection of defendants’ argument that to show market efficiency, plaintiffs must provide so-called “event studies” showing that the market price of the company’s stock price reacted quickly to the disclosure of new material information about the company. As in the Petrobras decision discussed in the previous article, though plaintiffs did in fact proffer an event study, the court held – consistent with a vast body of case law – that no one measure of market efficiency was determinative and that plaintiffs could demonstrate market efficiency through a series of other measures, which plaintiffs also provided here.

In so holding, the court observed that event studies are usually conducted across “a large swath of firms,” but “when the event study is used in a litigation to examine a single firm, the chances of finding statistically significant results decrease dramatically,” thus not providing an accurate assessment of market efficiency. The district court then found, following its extensive analysis, that plaintiffs sufficiently established market efficiency indirectly and thus direct evidence from event studies was unnecessary. Thus, the court went even further than the court in Barclays in downplaying the importance of event studies on class certification motions.

The district court also rejected defendants’ contention that certification should be denied because plaintiffs had supposedly failed to proffer a proper class wide damages model pursuant to the Supreme Court’s decision in Comcast. In rejecting that contention, the court recognized that the “Second Circuit has rejected a broad reading of Comcast” in its Roach v. T.L. Cannon Corp. decision. Indeed, the district court noted the Second Circuit’s finding in Roach that Comcast “did not hold that proponents of class certification must rely upon a classwide damages model to demonstrate predominance...[T]he fact that damages may have to be ascertained on an individual basis is not sufficient to defeat class certification.” The district court held that our expert’s proposal of using an event study and the constant dollar method to calculate damages is consistent with the theory of the case, and one that is typically used in securities class actions. The district court rejected defendants’ contention that plaintiffs should have proffered a model to identify and disaggregate confounding information as irrelevant, given that confoundinginformation would affect all class members the same.

Pomerantz Wins Class Certification In Two Major Cases: Class Certification Granted In Our Petrobras Case

Attorneys: H.Adam Prussin and Matthew C. Moehlman
Pomerantz Monitor March/April 2016

On February 2, 2016, Pomerantz achieved an important victory for investors when Judge Rakoff of the Southern District of New York certified two classes in our litigation against Petróleo Brasileiro S.A. – Petrobras, Brazil’s state run oil giant, concerning its involvement in one of the largest corruption and bribery scandals of the 21st century. One class consists of investors who purchased equity securities of Petrobras in the U.S. between 2010 and 2015. This class asserts fraud claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The other class consists of purchasers of debt securities Petrobras issued in public offerings in May 2013 and March 2014, who are alleging violations of Sections 11 and 12(a)(2) of the Securities Act of 1933. The lead plaintiff in the case is our client, Universities Superannuation Scheme.

The case concerns one of the most notorious securities frauds ever committed – a multi-year, multi-billion-dollar kickback and bid-rigging scheme. The scheme was allegedly orchestrated by former top Petrobras executives from at least 2004 onward, who systematically conspired to steer construction contracts to a cartel composed of 20-30 of Brazil’s largest contracting companies. The executives ensured that the contracts, padded by billions of dollars, were awarded to designated members of the cartel without any authentic competitive process. In return, the cartel kicked back hundreds of millions of dollars to the executives, who pocketed a cut of the bribe money, then gave the rest to their patrons in Brazil’s three ruling political parties. Revelations of this scheme decimated Petrobras’ stock price, devastating a class of investors. So far, five Petrobras executives have been convicted on criminal conspiracy and money-laundering charges, as well as a number of their confederates at the construction companies, and facilitating intermediaries.

As in many securities fraud cases, a central issue in the class certification motion was whether plaintiffs could establish that defendants committed “fraud on the market,” which allows investors to establish the element of reliance on a classwide basis. Failing this test would mean that reliance would have to be shown separately for each class member and that common questions would therefore not “predominate” over individual ones. To establish fraud on the market, plaintiff has to show that the securities in question trade on an efficient market, and that therefore defendants’ frauds affected the market price that each class member paid for purchasing Petrobras securities.

Courts have established a series of criteria for determining market efficiency, referred to as the “Cammer factors,” originally put together in a seminal case of that name. Most of these factors are indirect measures of market efficiency, including such things as the company’s market capitalization, the volume of trading in its securities, the typical bid-asked spread, the number of market makers in its shares and the number of analysts covering the company. The market for Petrobras securities easily passed all of these tests.

However, using an argument being pressed by defendants in most securities actions, the Petrobras defendants claimed that the most important Cammer factor is the “direct evidence” test, measured by how the market price of the company’s securities actually reacted to disclosure of unexpected news. This test, typically measured by socalled “event studies,” can be more difficult for investors to satisfy, because price movements in the real world can be affected by a host of market-moving information that can obscure the effects of the actual disclosure of the fraud. Defendants argued that this single factor trumps all the other Cammer factors and that it was not satisfied here because the market did not always react perfectly and instantaneously to unexpected disclosures. The district court held that plaintiff’s event studies were sufficient, and, more importantly, that perfect efficiency was not required:           

In assessing market efficiency, courts should not let the perfect become the enemy of the good. In this case, where the indirect Cammer factors lay a strong foundation for a finding of efficiency, a statistically significant showing that statistically significant price returns are more likely to occur on event dates is sufficient as direct evidence of market efficiency and thereby to invoke Basic’s presumption of reliance at the class certification stage. 

The court also rejected defendants’ argument that, because several large institutional investors had already “opted out” of the class, electing to pursue their own actions, investors were motivated to pursue their own actions and a class action was therefore unnecessary. To the contrary, the court determined that to deny class certification would plunge the courts into a morass of individual lawsuits and would do more harm than good.

Pomerantz News, At Home and Abroad

Pomerantz MonitorJanuary/February 2016

As part of its commitment to education, Pomerantz presented a moot court in January 2016 for advanced law students of Bar Ilan University in Israel. Daniel J. Kramer, Partner at Paul, Weiss, acted as counsel for the defense; Jeremy Lieberman as counsel for plaintiffs; and Marc Gross as judge. They argued Polycom, an actual securities fraud class action in which Pomerantz is lead counsel for the plaintiff class. The case alleges that the company was making positive statements about its operation and prospects, while it did not disclose that its CEO had submitted numerous false expense reports, claiming personal expenses as business expenses, and thereby misappropriating hundreds of thousands of dollars from the company.

 Meanwhile, on the home front, Pomerantz is proud to announce that Brenda Szydlo has joined the firm as Of Counsel in our New York office. Brenda has more than twenty-five years of experience in complex civil litigation in federal and state court on behalf of plaintiffs and defendants, with a particular focus on securities and financial fraud litigation, litigation against pharmaceutical corporations, accountants’ liability, and commercial litigation.

 Brenda is a 1988 graduate of St. John’s University School of Law, where she was a St. Thomas More Scholar and member of the Law Review. She received a B.A. in economics from Binghamton University in 1985.


ATTORNEY: H. Adam Prussin
Pomerantz Monitor January/February 2016




The Supreme Court has just issued two very significant rulings. In the first one, it granted certiorari to review U.S. v. Salman, a criminal insider trading prosecution. The case turns on the question of what sort of personal benefit, if any, a “tippee” has to give to his “tipper” in exchange for the inside information before the tippee can be liable for trading on it. This issue received national attention a few months ago when the Second Circuit gave its answer to this question in U.S. v. Newman; but the Supremes denied cert in that case.

 In Salman, defendant Salman received the inside information from a close friend who, in turn, had heard it from his brother. The question is whether the personal relationship between the two brothers in itself satisfies the “personal benefit” requirement for insider trading, or whether the government also has to show that the tippee brother gave an additional, tangible benefit to his brother in exchange for the information. In its decision, the 9th Circuit held that no additional tangible benefit, beyond the personal relationship, was required. In Newman, the Second Circuit previously held otherwise. Curiously, the 9th Circuit’s opinion was written by Judge Rakoff, a District Court judge sitting by designation. Judge Rakoff sits in the Southern District of New York, which is part of the Second Circuit. Through this quirk of fate, Judge Rakoff got another circuit court to disagree, publicly, with the Second Circuit’s Newman decision, which is binding on him when he sits as a district judge in New York.


In the Supreme Court’s second ruling, Campbell Ewold, it struck a blow against a tactic increasingly used by defendants in class actions: trying to “moot” the claims of the class representative by offering to pay all of his claimed damages. If the representative’s claim is mooted (i.e., satisfied), his individual claim would be dismissed, and the class would have no representative. If the class could not find another representative, the whole class action would be dismissed. If this could work, the class action device could be eviscerated.


Fortunately, the Supremes said no, finding that a rejected offer of settlement does not wipe out the representative’s claim; but, unfortunately, they left open the question of whether this tactic could work if, instead of just offering to pay the claimed damages, the defendant actually pays the money into an account for the benefit of the plaintiff, such as an escrow account or the clerk’s office. To resolve that question, we may need “Campbell Ewold 2.”



Pomerantz, the oldest securities law firm in the United States, proudly celebrates its 80th birthday

Pomerantz was founded in 1936 by Abraham L. Pomerantz, who, during his legendary career, relentlessly fought to protect investor rights. In doing so, he secured numerous victories now enshrined in the laws applied to securities class actions and derivative lawsuits.

Abe’s trailblazing spirit lives on at Pomerantz – from our historic Supreme Court victory recognizing the right to a jury trial in derivative actions in 1970, to being appointed sole lead counsel in 2015 in the action against Brazilian oil giant, Petróleo Brasileiro SA – Petrobras, surrounding its conduct in one of the largest corruption and bribery scandals of the 21st century. Although our client did not suffer the largest financial loss, the court found that Pomerantz’s outstanding reputation and the client’s conduct in overseeing counsel represented the “gold standard” for institutional investors seeking to move for appointment as lead plaintiff.

We are celebrating our 80 years with a bang. Pomerantz acts as lead counsel in a closely-watched securities class action lawsuit against ChinaCast Education Corp., stemming from its CEO’s alleged misappropriation of $120 million in company funds. The Ninth Circuit recently revived the case – after its dismissal by a lower court – ruling that the CEO’s fraud could be imputed to ChinaCast, even though his alleged embezzlement and misleading of investors went against the company’s interests. The litigation will now return to the lower court for trial.

Pomerantz is co-lead counsel in a securities class action against S.A.C. Capital Advisors LLC, in which the court recently certified two classes of plaintiffs. The case arises from the most profitable insider-trading scheme ever uncovered, in which the defendants illegally gained profits and avoided losses of at least $555 million from trades in Elan Corporation plc and Wyeth Pharmaceuticals, Inc. securities and related options while in possession of material, non-public information.

In 2015, Pomerantz defeated defendants’ motion to dismiss the class action against Barclays plc for misstatements about its “dark pool.” The court found that, although revenues from Barclays’ dark pool were under 5% of company revenues – a statistical benchmark often used to assess materiality – the misrepresentations went to the heart of its reputation and were therefore actionable. The decision is a victory for investors for its recognition that corporate integrity and ethics are material factors upon which investors rely when purchasing securities, even where the mounts of money involved fall below a presumptive numerical threshold.

Pomerantz acts as lead counsel for investors in a securities class action against Groupon for alleged misconduct related to its 2011 initial public offering, a case in which we have won every substantive motion to date. One of the most important milestones was our defeat of a defense motion to disqualify the plaintiffs’ class certification expert in March 2015. The defense argued that he was unreliable as he failed to conduct put-call parity and short lending fee analyses. We disagreed, citing the landmark U.S. Supreme Court ruling in Halliburton. After an extensive evidentiary hearing, the court sided with Pomerantz, holding that such tests were unnecessary because they addressed an extreme variation of market efficiency that “was squarely rejected by the Halliburton court.”

We are lead counsel in a securities class action against Walter Investment Management Corporation, in which the court dismissed our original complaint, while granting leave to file an amended complaint. Pomerantz then prevailed, overcoming the difficult burden to prove, in the motion to dismiss phase, that disclosure of a government investigation of and proposed enforcement action against the company satisfied the requirement for loss causation. Given the Myers/Loos standard prevailing in the Ninth and Tenth Circuits, which strictly limits the circumstances under which the announcement of a government investigation can be said to cause a loss, this victory is significant.



Auditing the Auditors

ATTORNEY: Joshua B. Silverman
Pomerantz Monitor January/February 2016


Investors rely on auditors to insure the integrity of corporate financial statements, but have little insight into the individual auditors themselves. That is about to change. A new rule adopted by the Public Company Accounting Oversight Board (PCAOB) will soon provide investors with much more transparency into the audit partners conducting the audit, and whether the audit firm outsourced substantial audit work.

Currently, auditors hide behind a mask of anonymity. They sign the opinion letters that go into SEC filings under the firm name only. But as recent PCAOB inspection reports confirm, even “big four” auditors produce shoddy audits with alarmingly high frequency. In its most recent inspection, the PCAOB found that KPMG was deficient in 54% of inspected audits. The remaining “big four” were only modestly better: EY 36%, PwC 29%, Deloitte 21%.

According to PCAOB chair James Doty, many of those bad audits were produced by particular engagement partners. In a recent statement, he explained that “PCAOB inspections have revealed that, even within a single firm, and notwithstanding firm-wide or network-wide quality control systems, the quality of individual audit engagements varies. There are numerous factors required to achieve a high quality audit, but the role of the engagement partner in promoting quality, or allowing it to be compromised, is of singular importance to the ultimate reliability of the audit.”

SEC enforcement actions confirm that some engagement partners are repeat offenders. For example, a recent action against Grant Thornton shows that the same partner, Melissa Koeppel, overlooked at least three major accounting frauds in public companies: headphone-manufacturer Koss, Assisted Living Concepts (ALC), and Broadwind. In its 2008 inspection of Grant Thornton, the SEC highlighted deficiencies in one of Ms. Koeppel’s audits. By the third quarter of 2010, Ms. Koeppel’s public company audit clients had restated financials four times, and Ms. Koeppel was on an internal monitoring list at Grant Thornton for partners with negative quality indicators. Her track record was so bad that Grant Thornton switched most of her audits to other engagement partners, but it kept her on the 2010 audit of ALC. Those financial statements had to be restated due to accounting irregularities that were brought to Ms. Koeppel’s attention by subordinates, but were ignored.

Investors will soon get a new tool to help identify bad auditors like Ms. Koeppel. A recently-adopted PCAOB rule will require audit firms to file forms indicating the name of the engagement partner. The rule also requires identification of other firms that assisted in the audit, and the extent of their participation.

While the rule is an improvement, it was watered down under heavy pressure from accounting industry lobbyists. The original proposal called for the engagement partner to be identified directly in SEC filings, either in the audit opinion itself or by the issuer. The current rule places the information in a separate form, so investors will have to look in multiple places to find information about the audit. But this additional hurdle is minor. Over time, it may not pose any problem at all, as financial information providers like Bloomberg and Reuters begin to link audit engagement partner  track record information into their profiles of corporate issuers.


Your Right to Know If Your Personal Information Has Been Hacked

ATTORNEY: Perry Gattegno
Pomerantz Monitor January/February 2016

In today’s digitized world, every day, nearly every consumer willingly or unwittingly shares sensitive personal information online. Almost as often, hackers successfully access corporate information databases, taking whatever data they can find.

Fortunately, nearly every state has data breach notification laws that apply to any entity that collects personally identifiable information. Those laws generally require the collecting entity to notify individuals when their personal information has been accessed by an unauthorized user. The first such law, enacted in California in 2003, set the model for data breach notification mechanisms by creating obligations for “any agency that owns or licenses computerized data that includes personal information.” In the case of a breach of security systems, the hacked company must disclose the breach to any California resident whose unencrypted personal information was, or is reasonably believed to have been, acquired by an unauthorized person.

The definition of personal information varies from state to state, but it generally includes names, telephone and Social Security numbers, home and e-mail addresses, and any information that falls under the umbrella of “personally identifiable information.” As defined by the California law, this extra information includes credit and financial data that creates access to private accounts, and driver’s license numbers. In California, only unencrypted information that has been transmitted to unauthorized persons must be reported, so California entities can obviate their reporting duties by encrypting all data.

Generally, the statutes include language requiring disclosure of the breach “without unreasonable delay,” (Connecticut, among others), “in the most expedient time possible” (Delaware, among many others) or “as soon as possible” (Indiana, among others). Most states allow the hacked company to wait until “delay is no longer necessary to restore the integrity of the computer system or to discover the scope of the breach,” or also to comply with a criminal or civil investigation by law enforcement. Some states, such as Louisiana, allow the breached entity not to notify consumers of a breach “if after a reasonable investigation the person or business determines that there is no reasonable likelihood of harm to customers.”

In the 13 years since the California law took effect, 47 states, as well as the District of Columbia, Guam, the U.S Virgin Islands and Puerto Rico, have enacted some form of data breach notification law. While they all authorize the local attorney general to enjoin violations and create civil and sometimes criminal penalties against violators, fewer than half the states also grant a private right of action to individuals whose data has been stolen. Civil penalties collectible by the state generally range from $100 to $2,500 per violation, while private rights of action generally permit aggrieved parties to recover actual damages, and often reasonable attorneys’ fees, from the hacked entity. These rights create a strong incentive to disclose these breaches to victims of a data breach. Illinois and California are among the states where a private right of action exists, while New York and Florida are among the states where there is no private right of action.

Nevertheless, holders of confidential data must also weigh the public relations nightmare that often accompanies data breaches, which are becoming high profile – and thus high-stakes – messes requiring immediate clean-up. Failing to comply with the relevant statute not only creates liability, it also causes embarrassment and discourages individuals from entrusting their data to the guilty party.

 Even those states that do not have a private right of action may have unfair trade practices statutes that may provide an alternative route to recovery. For instance, the Florida Deceptive and Unfair Trade Practices Act (FDUTPA) allows recovery of damages and attorneys’ fees for “unfair methods of competition, unconscionable acts or practices, and   unfair or deceptive acts or practices in the conduct of any trade or commerce.” Because FIPA, Florida’s data breach notification statute, defines a violation as an unfair or deceptive trade practice, the state statutory scheme essentially creates a single private right of action rather than FIPA creating a second one on top of the existing statute. FIPA merely creates a new category that falls under FDUTPA’s umbrella. The interplay around the country between analogous statutes varies by state.

Permitted methods of notification vary by state, but generally written notice, e-mail notice, or telephone/ fax notice are options if the breached entity has such consumer information in its possession. Some states permit alternatives in the vent that none of the previous methods are available, such as “Conspicuous posting of the notice on the Internet Web site page of the [breached] person or business, if the person or business maintains one” and “notification to major statewide media.”

Data breach notification laws confirm and crystallize the duties and obligations of entities that undertake to collect personally identifiable information of individuals. Even the best-intentioned holders of data may occasionally suffer unintentional breaches of information, but these laws incentivize stringent security and prompt action to mitigate harm wherever and whenever it might occur.



Court Upholds our Claims Against Lumber Liquidators

ATTORNEY: Michael J. Wernke
POMERANTZ MONITOR January/February 2016

Judge Allen of the Eastern District of Virginia recently denied defendants’ motion to dismiss our class action complaint against Lumber Liquidators Holdings, Inc. During the class period, the company, which sells hardwood and laminate flooring, reported record gross margins that were substantially higher than its major competitors’. Defendants represented that the major driver of these high margins was legitimate “sourcing initiatives” in China that supposedly reduced the cost of goods and cut out middlemen. In truth, however, the company’s high margins were due to importing cheap flooring made from illegally harvested wood and laminate that was contaminated with high levels of formaldehyde. When the truth emerged in a series of disclosures and events – including news of federal criminal charges for violations of the Lacey Act and the well-substantiated, televised broadcast by 60 Minutes of extensive wrongdoing -- the stock price plunged by 68%. In the aftermath, the board suspended the sale of Chinese laminate products, the CEO, CFO and the company’s “Head of Sourcing” abruptly resigned, and the company replaced its compliance officer.

The court held that the complaint adequately alleged that defendants’ statements were false: its increased margins were not due to legitimate “sourcing initiatives,” or to the company’s efforts to work with mills to produce flooring that meets their “high quality standard,” or to policies to ensure regulatory compliance, as the company had said. In fact, the company later admitted that its Chinese suppliers failed to adhere to regulations and that it did not build a compliance team in China until December 2014.

The court also held that the complaint raised a strong inference of scienter, because defendants had access to non-public information suggesting that their statements were false; third parties easily discovered the regulatory violations; defendants repeatedly discussed analyst calls regarding their personal involvement in the sourcing initiatives in China that were driving their margins higher; and defendants sold a majority of their stock during the class period. The court found that, given the importance and focus of the sourcing initiatives in China, it was part of the “core operations” of the business, another factor that supported the conclusion that management must have known the truth. Finally, the court imputed to management, and to the company, the knowledge of its head of sourcing.

Finally, the court found that the complaint adequately pleaded loss causation because the partial disclosures, when “taken together.... revealed the widespread scope of defendants’ allegedly fraudulent scheme.”

How Bad Does the Behavior Have to Be Before Shareholders Can Investigate It?

ATTORNEY: Anna Karin F. Manalaysay
Pomerantz Monitor January/February 2016

As the Monitor has previously reported, shareholders of Delaware corporations have a right to demand access to books and records of their company, provided that they have a “proper purpose” for doing so. One proper purpose is to investigate whether corporate officers and directors have violated their fiduciary duties. But merely expressing a desire to investigate such a possibility is not enough; the shareholder has to show that there are reasonable grounds to suspect that such a breach may have occurred. Many cases have explored the question of how much smoke there has to be to create a reasonable suspicion that there may well be a fire worth investigating.

Recently corporations have ratcheted up the argument. Now, they say, not only must there be grounds for suspicion of a breach, but that breach must be of the type that is compensable in damages. Since a books and records complaint is filed before there is any claim on file for breach of fiduciary duty, this argument requires that the court forecast the type of claim that might be made in the future.

Delaware law provides broad protections for directors against damage claims based merely on violations of the duty of care; only much more serious violations, such as breaches of the duty of loyalty, are compensable in damages. To escalate a claim of carelessness into a duty of loyalty claim, the shareholder must be able to show extreme misconduct -- the type of conduct that is hard to plead without company records to provide the crucial details. Those, of course, are the very details that the inspection provisions of Delaware law were intended to provide. It is to obtain such information that the shareholders bring a books and records proceeding in the first place. This question is now being considered by the Delaware Supreme Court in a case involving the AbbVie corporation, in which oral argument was heard on November 4, 2015.

In the action, Southeastern Pennsylvania Transportation Authority (“SEPTA”), a shareholder of AbbVie, sought access to AbbVie’s books and records relating to AbbVie’s failed $55 billion merger with Shire. Plaintiff claimed that it had a proper purpose because it wanted to investigate whether the AbbVie directors breached their fiduciary duties in connection with the approval of that merger.

The goal of the merger was to allow AbbVie to take advantage of Jersey’s more favorable tax laws, since Shire is incorporated in Jersey, a tiny island principality off the coast of Normandy that is controlled by England. If the merger had been consummated, AbbVie’s tax rate for 2016 would have dropped from about 22 percent to roughly 13 percent. About two months after the announcement of the merger, the Treasury Department and Internal Revenue

Service, alarmed over the possible drop in tax revenues from such “inversion” transactions, vowed to take action to deter American companies from acquiring foreign competitors to avoid domestic taxes. The AbbVie board responded by withdrawing its recommendation that stockholders vote in favor of the deal. The AbbVie board ultimately terminated the deal and paid Shire a $1.6 billion contractual termination fee.

SEPTA argued that it had a right to investigate the question of whether AbbVie would not have had to pay $1.6 billion if the AbbVie board had properly evaluated the risks of the merger, as required by their fiduciary duty. SEPTA demanded that AbbVie produce board minutes, correspondence, and other documents to investigate potential corporate wrongdoing.

In denying the books and record demand, Vice Chancellor Glasscock inferred that they were seeking an investigation to aid in future derivative litigation against the directors.

The court then held that if a plaintiff’s sole purpose for seeking inspection was to decide whether to bring derivative litigation to recover for alleged corporate wrong- doing, a proper purpose exists only if the plaintiff has demonstrated that the possible wrongdoing would be compensable in damages, and was not barred by the “raincoat” protections of Delaware law. Because SEPTA did not show that the conduct it was investigating could possibly rise to the level of a duty of loyalty claim, the court dismissed the inspection demand.

On appeal, SEPTA argued that the lower court’s decision essentially puts stockholders in the impossible situation of having to show exactly how serious the potential breaches of fiduciary duty might be before they could gain access to the records they would need to make that decision. AbbVie countered that without such detailed information, SEPTA was engaged in a mere fishing expedition, which the books and records statute does not allow.

Even if the appeal is denied, however, the Vice Chancellor, on several occasions, specifically noted that SEPTA sought inspection solely to investigate whether to bring derivative litigation, and that in order to state a proper purpose the claims must be non-exculpated. An exculpatory provision, however, does not bar all derivative litigation, and, accordingly, even in the face of an exculpatory provision, under certain circumstances investigating potential derivative litigation may still be a proper purpose. For example, claims seeking injunctive relief, such as an order barring consummation of a merger, or requiring additional disclosures, are not exculpated and therefore could be explored in a document inspection. At the early stage where a books and records case is filed, the plaintiff shareholder has not yet made any specific claims of actual wrongdoing, and can posit that, depending on what the documents may show, all sorts of non-exculpated relief could be possible.

Where's The Accountability?

Attorney: Tamar A. Weinrib
Pomerantz Monitor November/December 2015

At a conference last year, SEC Chair Mary Jo White began by asserting that “strong enforcement of our securities laws is critical to protecting investors and maintaining their confidence and to safeguarding the stability of our markets.” She went on to suggest that one of the SEC’s primary roles is to “bring wrongdoers to account and to send the strongest possible message of deterrence to would-be fraudsters.”

However, often the message sent is hardly one of deterrence. Many an SEC settlement amounts to nothing more than a mere “cost of business” for the wrongdoer, which is ultimately borne by the shareholders, particularly where the settlement terms do not require any accountability. Indeed, it was for precisely this reason that Judge Rakoff initially rejected the SEC’s $285 million settlement with Citigroup in 2011 that stemmed from the bank’s sale of mortgage-backed securities that cost investors $700 million but yielded a $160 million profit for the bank. Judge Rakoff referred to the settlement, which required no admission of wrongdoing, as “pocket change.”

Although the SEC has obtained admissions of wrongdoing in some cases, the Citigroup settlement was not unique in its failure to require Citigroup to either admit or deny liability (indeed Judge Rakoff rejected a settlement between the SEC and Bank of America in 2009 for similar reasons) but it prompted Judge Rakoff to proclaim that it “is neither fair, nor reasonable, nor adequate, nor in the public interest.” Just last month, the SEC entered into yet another settlement with two units of Citigroup that holds no one at the bank accountable for selling municipal bonds to wealthy clients for six years as a safe money option despite the innate risk resulting from considerable leverage, which caused investors to lose an estimated $2 billion. This settlement, for $180 million, like the settlement in 2011, did not require Citigroup to either admit or deny wrongdoing. Once again, it is the innocent investors who will bear the settlement cost.

The SEC is not alone in its zeal to settle claims with no accountability. The New York State Attorney General announced a settlement with Bank of America and former CEO Ken Lewis in 2014 over statements made in connection with the 2008 BofA and Merrill Lynch merger. Specifically, the SEC accused BofA of failing to reveal the truth about $9 billion in losses at Merrill Lynch before voting to approve the merger. After the merger, BofA needed a federal bailout partly because of the increasing losses at Merrill Lynch, and investors suffered when shares took a nosedive. The $25 million settlement did not require any admission of wrongdoing by either BofA or Lewis. Moreover,

BofA ultimately paid the $10 million of the settlement amount that Lewis was supposed to pay. In other words,

Lewis walked away from the settlement unscathed and therefore undeterred. Settlements such as these are ineffectual at deterring future misconduct by either the settling party or other entities and executives.

The question, however, is what the consequences are of the alternative. There exists a particularly sharp double-edged sword when considering the nature of the “deterrent.” The obvious concern is that if regulators continue to enter settlements that require no admissions of wrongdoing, those settlements will unlikely deter future misconduct but rather create a cost of business that further victimizes, rather than protects, investors. However, on the flip side, if regulators were to require admissions of wrongdoing as a condition to any settlement, the risk is that far fewer such actions/investigations would result in a settlement. Companies hesitant to admit any wrongdoing lest an investor or other party use that admission against it in a private lawsuit will not as readily agree to settle, which will undoubtedly result in protracted and costly litigation with uncertain outcomes. The question is what is the true goal --- to deter future misconduct as regulators consistently proclaim or to settle as many actions as possible, thereby avoiding the costs of lengthy litigation and the withering of budgetary constraints?

 Perhaps the greatest deterrent to securities fraud would be criminal prosecutions of individual wrongdoers, which is the prerogative of the Justice Department. The track record there has, if anything, been even spottier. The recent spate of insider trading convictions has been drastically undermined by the Second Circuit’s landmark ruling in the Newman case, which raises the bar dramatically for insider trading convictions. Other types of securities fraud criminal convictions of individuals are almost completely nonexistent.


Shareholder Approval Of Merger Held To Eliminate Claims Against Conflicted Investment Bankers

Attorney: Matthew C. Moehlman
Pomerantz Monitor November/December 2015

On October 29, 2015, Vice Chancellor Parsons of the Delaware Court of Chancery dismissed the sole remaining claim in In re Zale Corporation Stockholder Litigation, the shareholder suit arising from Zale’s 2014 merger with Signet Jewelers Ltd. The Zale opinion, in which Parsons reversed his own earlier ruling in light of binding new precedent from the Delaware Supreme Court, serves as a blunt reminder to investors that Delaware courts are highly reluctant to meddle with the decisions of corporate boards.

In the suit, the Zale plaintiffs had alleged that they were cashed out of their investment at an unreasonably low price due to the involvement of a conflicted financial advisor, Bank of America Merrill Lynch. Zale’s Board of Directors retained Merrill Lynch to advise it as to the financial fairness of the merger. In accepting the engagement, Merrill Lynch failed to inform the Board that it had recently met with Signet to pitch an acquisition of Zale. Notably, the same Merrill Lynch investment banker who led the team advising Zale’s Board had also led the team that pitched to Signet. Further, in the pitch meeting, Merrill Lynch had suggested that Zale pay no more than $21 per share for Zale, and ultimately, the merger was approved by Zale’s Board for an acquisition price of $21 per share. Finally, while Merrill Lynch ultimately informed the Board of its meeting with Signet, it waited to do so until after the merger was announced.

On those allegations, the plaintiffs asserted a claim for breach of fiduciary duty against the Board for insufficiently vetting Merrill Lynch for potential conflicts of interest, and against Merrill Lynch for aiding and abetting the Board’s breach by concealing the conflict from it. Plaintiffs sued Merrill Lynch as aiders and abettors because the bankers owed no fiduciary duties to shareholders.

Initially, Vice Chancellor Parsons found that the plaintiffs had plausibly alleged that Zale’s Board had breached its duty of care to shareholders by not ferreting out Merrill Lynch’s conflict. Parsons noted that Zale had “rather quickly decided to use Merrill Lynch, the only candidate they considered,” and did not ask probing questions designed to detect conflicts of interest, such as whether the bank had made any presentations regarding Zale to prospective buyers within the last six months. Nevertheless, Parsons dismissed the Board from the suit due to an exculpatory charter provision—a protection permitted by Delaware statute that insulates directors from damage claims based on breach of their duty of care. But Parsons sustained the aiding and abetting claim against Merrill Lynch for failing to promptly disclose its meeting with Signet to the Board, which potentially allowed Signet to have the upper hand in negotiations.

However, the day after Parsons issued his opinion, the Delaware Supreme Court undercut it. Specifically, in Corwin v. KKR Financial Holdings LLC, the high court held that a fully-informed vote by an uncoerced majority of disinterested stockholders invoked the deferential “business judgment” standard of review. Practically speaking, business judgment review precludes second guessing of Board decisions, and its application is typically outcome-determinative against shareholder plaintiffs.

The Zales-Signet merger had been approved by 53% of Zale’s shareholders. Accordingly, under Corwin, Parsons should have evaluated the Board’s conduct in vetting Merrill Lynch under the business judgment standard. Parsons had instead applied the stricter “enhanced scrutiny” standard of review. Parsons held that enhanced scrutiny was appropriate under the Delaware Supreme Court’s 2009 decision in Gantler v. Stephens, which he found did not mandate business judgment review where a shareholder vote was statutorily required. Corwin clarified that Parsons had misread Gantler. Corwin said where the approving shareholders were disinterested, fully-informed and uncoerced, it did not matter whether their vote was required or purely voluntary—business judgment was the standard of review. Corwin thus made it exceptionally difficult to find that Zale’s Board had breached its duty of care to shareholders. And because Merrill Lynch’s liability as an aider and abettor was predicated on the Board’s duty breach, the Corwin holding benefitted it as well.

So, after politely holding off for three days —no doubt to give the Zale plaintiffs time to wind up their affairs and come to terms with the inevitable—Merrill Lynch moved for reargument in light of the holding in Corwin. Parsons saved Merrill Lynch the trouble, reconsidering his earlier ruling and dismissing the bank from the case. Perhaps showing his ambivalence at the result, he observed that, “The conduct of Merrill Lynch in this case is troubling, and it was disclosed only belatedly to the Zale Board.”

In a broad sense, the Zale opinions, and the holding in Corwin, illustrate the substantial protections that Delaware continues to afford the directors of companies incorporated there—estimated to be 50% of all U.S. public corporations. By clarifying that banker conflicts may be scrutinized less after a merger receives shareholder approval, it also marks an important qualification to the series of scathing banker conflict opinions that have boiled out of the Court of Chancery in recent years.

For example, in In re Del Monte Foods Co. Shareholders Litigation, Vice Chancellor J. Travis Laster found that Del Monte’s financial advisor Barclays PLC had “secretly and selfishly manipulated the sales process to engineer a transaction that would permit Barclays to obtain lucrative buy-side financing fees.” Likewise, in In re El Paso Corporation Shareholder Litigation, former Chancellor, now Chief Justice of the Delaware Supreme Court, Leo Strine skewered El Paso Board advisor Goldman Sachs for “troubling” conduct that led him to conclude that the transaction was “tainted by disloyalty.” And in In re Rural/Metro Corporation Stockholders Litigation, Vice Chancellor Laster took aim at RBC Capital for steering Rural/Metro’s Board to consummate a deal with an acquirer that RBC secretly hoped would hire it to provide financing for the transaction.

Such rulings are salutary because they recognize that bankers wield considerable influence in merger transactions, and that a self-interested sell-side banker can prevent shareholders from realizing maximum value when cashed out of their investments. As the outcome in Zale shows, Corwin makes it that much more difficult to show director liability after a merger has been consummated. The further rub for investors is that, after Corwin, bankers enjoy more flexibility to act selfishly and against shareholders’ interests —so long as they make the perfunctory disclosures, the deal gets done, and the merger is approved.


Petrobras Court: Opt-Outs Beware

Attorney: Mark B. Goldstein
Pomerantz Monitor November/December 2015

As reported in previous issues of the Monitor, Pomerantz is lead counsel in a class action lawsuit against the Brazilian oil giant Petrobras. Lead Plaintiff Universities Superannuation Scheme Limited and additional institutional plaintiffs allege securities fraud violations that stem from a large-scale undisclosed bribery and money-laundering scheme that caused tens of billions of dollars of damages to shareholders. On July 9, 2015, the court denied most of defendants’ motions to dismiss, upholding, most notably all of our Securities and Exchange Act claims. The class includes investors who purchased their Petrobras shares after January 22, 2010.

Some investors had decided to opt out of our class action, and to file individual suits. Defendants moved to dismiss their claims as well; and on October 19, 2015, Judge Jed S. Rakoff of the Southern District of New York dismissed their claims “to the extent such claims under Section 10(b) of the Exchange Act cover purchases prior to June 2, 2010, on the ground that such claims are barred by the statute of repose.”

In our class action, by contrast, the court upheld claims going back six months earlier, to January 22, 2010. Therefore, by opting out, these individual plaintiffs forfeited six months’ worth of claims.

 The statute of repose for the Exchange Act bars claims brought more than five years after the occurrence of the fraud. The fraud is deemed to have occurred on either the date the investor purchased the stock or the date of the act or transaction constituting the violation.

 Unlike a statute of limitations, the statute of repose is not concerned with when the investor discovers that he or she has a claim for securities fraud. It acts as a bar to all claims under the securities laws and begins to run from the date the investor purchased the security or from the date of the act or transaction constituting the violation. This five year period had not yet run on any of our claims when we brought our class action.

In opposing the motion to dismiss, the opt-out plaintiffs argued that the statute of repose should be tolled (stopped) for the period these plaintiffs were part of the class. In a case called American Pipe the Supreme Court held that such tolling applied to the statute of limitations: “the commencement of a class action suspends the applicable statute of limitations as to all asserted members of the class.” There currently exists a split among the circuits regarding whether the American Pipe doctrine applies to plaintiffs who elect to opt out of a pending class action prior to a decision on class certification, and a number of district courts, the Sixth Circuit, and the First Circuit have held that tolling of the statute of limitations is not available in such circumstance.

 However, in a case called IndyMac, the Second Circuit held two years ago that the statute of repose under the Exchange Act is not covered by American Pipe tolling. In particular, the Second Circuit ruled, “in contrast to statutes of limitations, statutes of repose create a substantive right in those protected to be free from liability after a legislatively- determined period of time.” The reasoning is that the statute of repose allows issuers and underwriters of securities to know, by a date certain, when all potential claims arising out of a particular securities issuance have been extinguished. This holding was followed by Judge Rakoff when he dismissed the opt-out plaintiffs’ claims covering Petrobras purchases prior to June 2, 2010.

While there may sometimes be good reasons for institutions with large claims to opt out of a class and bring their own actions, they do so at the risk that they will lose some of their claims because of the statute of repose.

Pomerantz Beats The “Adverse Interest” Exception Again

Attorneys: Marc C. Gorrie and Emma Gilmore
Pomerantz Monitor November/December 2015

A few months ago the Monitor reported that Pomerantz had defeated a motion to dismiss our Petrobras action, persuading the District Court to reject a defense based on the so-called “adverse interest” rule. There we persuaded the court that the company, Petrobras, a Brazilian company, could be responsible for frauds committed by its senior executives. Contrary to the company’s arguments, the court concluded that Petrobras derived some benefits from the frauds and its interests were therefore not entirely adverse to those of the individual wrongdoers.

Now we have prevailed over that defense again, this time in a case involving a Chinese company, ChinaCast. In a resounding victory for the firm and the class of investors we represent, the United States Court of Appeals for the Ninth Circuit, in a question of first impression, unanimously held that a senior corporate employee’s fraud is imputed to the corporation even when the fraud actually is completely adverse to the company’s interests. ChinaCast is a for-profit, post-secondary education and e-learning service provider that gives courses online and on three physical campuses in China. Founded in 1999, its shares traded on the NASDAQ Global Select Market, at one time boasting a market capitalization of over $200 million. In March of 2011 ChinaCast filed a Form 10-K with the Securities and Exchange Commission in which it disclosed that its out-side accounting firm, Deloitte Tohmatsu CPA, Ltd., had identified “serious control weaknesses” in its financial oversight systems.

Both sides in our case essentially agreed on the underlying facts. A massive fraud occurred at ChinaCast when its CEO and founder, Ron Chan Tze Ngon, looted the company and brought it to financial ruin. Chan improperly transferred $120 million of corporate assets to bank accounts that he and his associates controlled, allowed a vice president to transfer $5.6 million in Company funds to his son, transferred control of two colleges outside of the Company, and pledged $37 million in company funds to secure loans unrelated to ChinaCast’s business.

Afterwards, Chan and ChinaCast’s CFO Antonio Sena failed to disclose this critical information to investors. Instead, through a series of earnings calls and SEC filings, they assured the market of ChinaCast’s financial stability and sound accounting controls. When the extent of the scheme was finally uncovered in early 2012, ChinaCast’s Board of Directors removed Chan as CEO, and Sena stepped down. Several class action suits were commenced on behalf of investors in the Central District of California in September 2012, and Pomerantz was appointed Lead Counsel for the class.

The district court dismissed plaintiff’s claims on the grounds that scienter, a “bedrock requirement” of a suit brought under Section 10(b) of the Securities Exchange Act of 1934, was not adequately pled against ChinaCast. Scienter requires a plaintiff to plead facts creating a “strong inference” that the corporation acted with “intent to deceive, manipulate, or defraud.” The district court found that the actions and intentions of Chan and his accomplices, however detestable, could not be imputed to ChinaCast under the “adverse interest” rule.

The general rule in securities fraud cases is that a corporate executive’s scienter is imputed to the company, as the company can only act, and formulate intent, through its employees. Where the executive is high enough in the corporate hierarchy, such as CEO Chan was here, his knowledge is the knowledge of the company. However, the adverse interest exception precludes imputation of knowledge where the employee acts solely in his own interest, injuring the corporation. The district court held that Chan’s frauds benefited himself at the expense of the corporation, and therefore satisfied the adverse interest exception to the imputation rule.

On appeal, the Ninth Circuit reversed this ruling. Pomerantz managing partner Marc Gross persuaded the court that a longstanding exception to the adverse interest exception applied. Known as the “apparent authority” or “innocent third party” exception to the exception, this doctrine “holds where a person reasonably relies upon the apparent authority of an agent, that misconduct of the agent is therefore imputed to the corporation, in this case the CEO and the company,” even if the misconduct is detrimental to the company. Pomerantz argued that imputing knowledge when innocent third parties are involved advances public policy goals in that it is the company that has selected and delegated responsibility to its executives, the doctrine creates incentives for corporations to do so carefully and responsibly.

The Ninth Circuit agreed, holding that “the adverse interest rule collapses in the face of an innocent third party who relies on the agent’s apparent authority.” In other words, a corporation can be held liable to investors even where officer’s actions are adverse to that corporation’s interest when they rely in good faith on that officer’s representations.”

The Ninth Circuit’s opinion is significant because it adopts a bright-light rule where, on a well-pled complaint, “having a clean hands plaintiff eliminates the adverse interest exception in fraud on the market suits because a bona fide plaintiff will always be an innocent third party.”

Managing Partner Marc Gross, who argued before the Ninth Circuit panel, stated that Pomerantz is “very pleased that the Ninth Circuit has made clear that corporations are accountable for defrauding investors, as they should be, even when the company’s own coffers have been looted by its own officers. After all, the corporation hired the officers and should be held responsible for how their misconduct impacts innocent investors."

The Importance of Being Advanced

Attorney: Gustavo F. Bruckner
Pomerantz Monitor September/October 2015

Delaware is the state of incorporation for over 50% of all publicly traded corporations in the United States and 60% of the Fortune 500 companies. Delaware court decisions on issues of corporate law thus have far-reaching ramifications. A series of cases involving the rights of corporate directors for advancement and indemnification of legal fees shows just how important these rights are considered, even when they involve corporate wrongdoers. When a director is sued for his actions as a director, he may be entitled not only to be reimbursed for his defense costs after the case is over, but to have these costs paid immediately, even before there is a determination as to whether the case has merit and before it is decided whether or not he should be indemnified.

Although a seat on a corporate Board of Directors can be prestigious and often lucrative, it carries with it certain risks -- including the risk of liability for breaching fiduciary duties. Yet, because directors are not usually executives, they don’t always have the same level of involvement and awareness of the affairs of a company that day-to-day management has. Generally, the Business Judgment Rule protects a director from personal liability to the corporation and its stockholders for an unwise corporate decision so long as the director acted in good faith, was reasonably informed and believed the action taken was in the best interests of the corporation. Delaware General Corporation Law section 145 provides that corporations shall indemnify officers and directors (that is, pick up their defense costs incurred in successfully defending claims of corporate governance breaches). The Delaware courts have previously held that “the statute requires a corporation to indemnify a person who was made a party to a proceeding by reason of his service  to the corporation and has achieved success on the merits or otherwise in that proceeding [mandatory indemnification]. At the other end of the spectrum, the statute prohibits a corporation from indemnifying a corporate official who was not successful in the underlying proceeding and has acted, essentially, in bad faith.” In between, a corporation has the flexibility to indemnify its officers and directors, if they acted in good faith and without a reasonable belief that their conduct was criminal (permissive indemnification).

Since these costs cannot be determined until after the case is over, Delaware has also allowed corporations to agree to advance defense costs to officers and directors who find themselves defendants in such cases. This is seen as a way to attract top talent otherwise frightened of potential litigation. The advancement is usually subject to an “undertaking” by the director to repay any advancement if the director is ultimately not found to be entitled to indemnification. The law allows a corporation more latitude to provide advancement to current officers, but allows more conditions to be imposed on the benefit granted to former directors and officers, thus making an important distinction between current and former officers.

In Holley v. Nipro Diagnostics, Inc., the Delaware Chancery Court affirmed last year how seriously it takes these obligations to advance defense costs. Holley was the founder and Chairman of a medical device manufacturer, Home Diagnostics, that was acquired by Nipro in 2010. Pursuant to the acquisition, Nipro assumed Home Diagnostics’ advancement obligations to Holley “to the maximum extent permitted under the General Corporate Law of Delaware” for the costs of defending claims asserted against Holley “by reason of the fact” that he was a director of the Company. Soon after the merger closed, the SEC began an investigation into insider trading and initiated a civil enforcement action against Holley for disclosing non-public information to friends and family. Holley sought and received advancement of defense costs related to the SEC investigation. A month later, Holley was indicted on charges of criminal securities fraud. The SEC civil action was stayed pending resolution of the criminal action. After successfully getting the court to dismiss two of the criminal counts, Holley pled guilty to two additional counts and in exchange the government agreed to dismiss the three remaining counts. Thereafter the SEC civil enforcement action resumed and Holley sought advancement of his costs of defending that action. When Nipro refused, Holley brought suit.

Nipro argued that Holley was not entitled to advancement for the following reasons: he was not a party to the SEC enforcement action “by reason of the fact” that he was a director, but rather due to personal misconduct; since he pled guilty to insider trading he could not be indemnified and thus advancement would not be permissible; and public policy grounds. The Court rejected Nipro’s arguments. First, the Court found that the SEC investigation focused on the breadth and depth of inside information Holley possessed as a result of his position. The Court also held that “in advancement cases, the line between being sued in one’s personal capacity and one’s corporate capacity generally is drawn in favor of advancement with disputes as to the ultimate entitlement to retain advanced funds being resolved later at the indemnification stage.” The Court made clear that the right to advancement is separate and apart from the right to indemnification, with the right to advancement not dependent on the right to indemnification.  Nevertheless, the Court held that notwithstanding the guilty plea, Holley might be entitled to indemnification since the guilty plea did not necessarily preclude success on the SEC claims, which alleged misconduct beyond that encompassed in his guilty plea. The Court rejected the public policy arguments on the same grounds. To emphasize the importance of this issue, the Court also awarded Holley the fees incurred in litigating his advancement claims.

A few months later the Chancery Court once again reached the same conclusion in Blankenship v. Alpha Appalachia Holdings, Inc. Blankenship was CEO and Chairman of Massey Energy Company when a massive explosion at one of Massey’s mines killed twenty-nine miners. Blankenship retired soon thereafter and Massey was acquired by Alpha Natural Resources. As part of the merger, Massey asked Blankenship to sign a new undertaking which added language that Massey’s advancement of expenses was contingent upon Blankenship’s representation that he “had no reasonable cause to believe that his conduct was ever unlawful.” After the merger, Blankenship incurred legal expenses, which Massey paid, arising out of the government’s investigation of the mine explosion. When the government later criminally indicted Blankenship, Massey and Alpha determined that Blankenship breached his undertaking and ceased advancing the costs of his defense. Blankenship brought suit and, in a post-trial opinion, the Court found in his favor. Emphasizing the importance of advancement, the first sentence of the opinion states, “this advancement action involves some unusual facts but an all too common scenario: the termination of mandatory advancement to a former director and officer when trial is approaching and it is needed most.” The Court went on to find that the revised undertaking could not justify terminating advancement in the middle of Blankenship’s defense. Massey’s advancement obligations to Blankenship under its charter survived Alpha’s acquisition of Massey under the terms of the Merger Agreement between those parties. Because Massey’s charter required it to advance costs to the maximum extent provided by Delaware law, Massey could not then condition its advancement obligations on anything other than an undertaking to repay the expenses if it is later determined that indemnification is not appropriate. The Court also awarded Blankenship his reasonable expenses incurred in litigating the advancement action. These results comport with a spate of cases since Holley involving claims for advancement that have ended with similar results.

Most recently the court did find there are limits to advancement, in two cases over two consecutive weeks. In Lieberman v. Electrolytic Ozone, the Chancery court found that post-employment conduct did not entitle former officers to advancement. Lieberman and Lutz were the CEO and VP Engineering, respectively, of Electrolytic Ozone. They had signed non-disclosure and non-compete agreements. In December 2013 they were terminated as part of a consolidation of operations. Electrolytic also terminated a 10-year supply contract with Franke Foodservice Systems two years into the contract. Franke initiated arbitration against Electrolytic for breach of the supply agreement. Lieberman and Lutz went to work for Franke in February 2014. In June 2014, Electrolytic raised third-party claims against Lieberman and Lutz for breach of their employment, non-disclosure and non-compete agreements.

Lieberman and Lutz brought suit after Electrolytic refused to provide them advancement. The Court held that Lieberman and Lutz could only be entitled to advancement of fees for litigation brought “by reason of the fact” that they served as EOI directors, officers or employees. Although the Court said the test is broadly construed, it found that the “arbitration claims are confined to post-termination actions and do not depend on [Lieberman and Lutz’s] use of corporate authority or position.” The Court went on to note that Electrolytic’s contractual claims were derived from specific contractual obligations that were allegedly breached post-termination. Thus Lieberman and Lutz were not entitled to advancement.

In Charney v. American Apparel, Inc., the Court held that the permissive indemnification written into a post-employment standstill agreement was not as broad as the indemnification
granted under the law. Charney, founder and former CEO/chairman of American Apparel, was forced out of the company after revelations of sexual harassment and initiation of lawsuits emanating from such allegations. He was suspended as the company’s chief executive officer in June 2014, resigned as a director of the company in July 2014 and was terminated for cause as CEO in December 2014. Thereafter, the company brought suit against Charney, alleging that after he was no longer CEO he violated the nomination, standstill and support agreement under which he agreed to not disparage the company or to run a proxy contest for the company’s board of directors. Charney sought advancement of his legal expenses in defending against the case under an indemnification agreement he had with American Apparel, which mandates the advancement of legal costs “related to the fact” that Charney was a director or officer of the company.

The Court concluded that these claims did not involve any alleged “use or abuse of corporate power as a fiduciary of American Apparel,” and thus Charney could not be entitled to indemnification under the terms of the contract. Additionally, the company’s charter only mandates advancement for current officers and directors. Therefore, the Court found that Charney could not receive advancement.

However, the facts in Charney and Lieberman differ from most advancement cases in that the questionable conduct occurred when those seeking advancement were no longer directly employed by the company. In contrast, Blankenship sought advancement when he was no longer employed by the company but it was to defend conduct that occurred while he was still employed. And as Holley v. Nipro shows, even criminal behavior may not be sufficient to preclude advancement.

District Court Upholds Our Claims Against Galena Biopharma

Attorney: Jennifer Banner Sobers
Pomerantz Monitor September/October 2015

In August, Pomerantz won an important victory for investors against Galena Biopharma, certain of its officers and directors, and others when the district court of Oregon largely rejected defendants’ motion to dismiss the action. 

The complaint alleges that defendants manipulated the market price of Galena stock when Galena hired Dream-Team, a promotional consulting company, to publish bullish articles to inflate Galena’s stock. According to the complaint, DreamTeam published articles on websites touting Galena and falsely claiming that the articles were written by established, credible investment professionals, whereas in fact the articles were paid promotions using a variety of aliases for the “authors”. Investors reading the many varied web and social media positive postings about Galena could conceivably be convinced that they should invest in the company. While Galena stock was being pumped up, Galena’s officers dumped large amounts of company stock, reaping enormous profits. In short, this was a classic “pump and dump” scheme.

Defendants’ motion to dismiss relied primarily on the argument that under a recent Supreme Court case, Janus Cap. Grp. Inc. v. First Derivative Traders, only the “maker” of a statement can be held liable for alleged misrepresentations and omissions in violation of the securities laws. Here, they claimed, only the individual authors of the articles hired by the third party stock promoters were “makers” of these statements In response, we argued that, under Janus, the maker of a statement is not just the person identified as the author, but the person or entity with ultimate authority over the content and communication of the statement. Since Galena officers had final authority over the articles and had to approve the content before they were published, Galena and its officers were the “makers” of the allegedly false statements. 

The District Court agreed with us and refused to extend the holding of Janus to say that only the individual authors were “makers” of the statements. The Court noted that if it were to consider the individual authors as the makers of those statements, then companies could avoid liability under the securities laws by paying third parties to write and publish false or misleading statements about the company, even when the company retains final decision    making authority over content.

Defendants also argued that the articles were written by and attributed to the individual authors, and under Janus, the attribution within the articles serves to prove that the authors are the “makers” of the statements. The District Court did not agree. The Supreme Court in Janus noted that in the “ordinary case” attribution within a statement is strong evidence that the statement was made by the party to whom it is attributed. However, the District Court found that this case is not ordinary and attributions under false aliases like “Kingmaker” and “Wonderful Wizard” are meaningless, as no reasonable reader would believe that the statements were made by people with those names. Moreover, the purported biographies associated with the author aliases were allegedly false. Thus, the District Court found that the attribution was not strong evidence that the false aliases were the “makers” of statements contained in the articles.

However, the District Court did hold that Galena, as the only party that had ultimate authority over the published articles, was the maker of these statements, and not also the DreamTeam as we argued. The Court noted that the lesson of Janus is that where legally distinct entities are involved, only one entity has the final say in what, if anything, is published.

Defendants’ motion to dismiss also invoked the so-called “truth on the market defense,” arguing that defendants’ alleged misstatements could not have been material because corrective information was already disclosed to the market. This “corrective” information was supposedly revealed by an obscure website, which disclosed that one of the stock promoters touting the company was receiving compensation from Galena.

The District Court rejected that argument, holding that it is not reasonable for investors to have to research every stock promotion-related website to make sure that each company recommended by purportedly independent analysts and investors has not hired a promotional firm to engage in secret stock promotions. Moreover, as alleged in the complaint, further evidence that the paid promotional campaign was not already incorporated into Galena’s stock price was that after articles revealing the fraudulent scheme were published, the company’s stock price dropped significantly. Defendants in securities cases often attempt to rebut materiality allegations by showing that corrective information was published on some obscure website or in an article that is not widely circulated. Thus, the District Court’s finding on this point is an important victory for investors.

Update: Another Go-Around For Loss Causation In The Ninth Circuit

Attorney: Michele S. Carino
Pomerantz Monitor September/October 2015

Ten years ago, in its seminal decision in Dura Pharmaceuticals, Inc. v. Broudo, the Supreme Court held that in a securities fraud case the plaintiffs must allege facts establishing “loss causation,” meaning that the misrepresented or omitted facts actually caused losses for investors. This can occur, for example, when the company makes a “corrective disclosure” that reveals new or previously concealed information concerning the true state of the company’s affairs, which then causes the price of its stock to drop.

Since then, there has been a great deal of discussion as to how to apply the Dura rule, especially in cases where there has not been a single, or obvious, corrective disclosure. Recently, the Ninth Circuit has been asked to provide  some much-needed clarity in this area.

In August, in Smilovits v. First Solar Inc., a federal district court in Arizona certified for immediate interlocutory appeal the issue of the correct standard to apply for pleading loss causation in cases where the company does not explicitly “correct” any previous disclosures – i.e. admit that they were false or misleading. In such cases, two conflicting standards have emerged in the Ninth Circuit post-Dura, which the district court concluded would yield contradictory results in the case before it. First Solar involves allegations that the defendants withheld information about certain manufacturing defects in their products. Eventually, those defects started to affect the company’s financial condition, and its stock began to decline, falling from nearly $300 per share to less than $50 per share. Plaintiff identified six stock price declines following announcements of disappointing financial results. Although plaintiff claimed that the poor results were actually caused by these undisclosed manufacturing defects, the company did not admit it.

Applying the test articulated in Nuveen Mun. High Income Opportunity Fund v. City of Alameda, plaintiff contended that loss causation is satisfied “by showing that the defendant misrepresented or omitted the very facts that were a substantial factor in causing the plaintiff’s economic loss.” On the other hand, defendants urged the court to adopt a much narrower view, which would require not only that the misrepresented or omitted facts caused the loss, but that the company admitted that its previous statements were wrong.

In support of this argument, defendants relied on another line of Ninth Circuit case law beginning with Metzler Investment GMBH v. Corinthian Colleges, Inc. The Metzler line of cases requires a showing that “the market learn[ed] of a defendant’s fraudulent act or practice, the market react[ed] to the fraudulent act or practice, and plaintiff suffer[ed] a loss as a result of the market’s reaction.” According to defendants, since First Solar’s poor earnings announcements were not accompanied by any revelation of a prior fraud, plaintiff could not demonstrate the requisite “causal connection” between defendants’ alleged misrepresentation or omission and plaintiff’s loss.

The district court ultimately determined that Nuveen stated the better rule, holding that the requirements of proximate cause are satisfied so long as the misrepresented fact led to the plaintiff’s loss. Thus, it does not matter whether the company reveals that it has committed a fraud. As the district court explained: “If the plaintiff can prove that the drop in revenue was caused by the misrepresented fact and that the drop in his or her stock value was due to the disappointing revenues, the plaintiff should be able to recover. A causal connection between the ‘very fact’ misrepresented and the plaintiff’s loss has been established.”

An affirmance in First Solar by the Ninth Circuit potentially would have far-reaching implications, because it would prevent companies from averting liability simply by refusing to admit that misstatements had been made. It might also put an end to the ongoing dispute over whether the announcement of governmental investigation, followed by a drop in a company’s stock price, satisfies the loss causation test under Dura. The Ninth Circuit has adopted the reasoning in Loos v. Immersion, which like Metzler, holds that disclosure of an investigation is insufficient to establish loss causation, because “[t]he announcement of an investigation does not ‘reveal’ fraudulent practices to the market,” but only the possibility that a fraud may have occurred. Loos requires something “more” – presumably, some revelation or actual accusation of fraud. However, as the First Solar court recognized, application of Nuveen in cases like Loos yields a completely different outcome, so long as plaintiffs establish that the ‘very fact’ misrepresented, e.g., the undisclosed fraudulent conduct prompting the investigation, caused the stock to decline in value.

The First Solar approach also makes eminent sense as a policy matter. Requiring revelation of fraud before losses are actionable rewards defendants who issue bare bones disclosures or time the announcement of poor financial results to coincide with other events, even though they may have knowledge of the real causes of the company’s difficulties. When and if an actual fraud is revealed, there may be no subsequent price decline, as the market has already incorporated and accounted for the previously-disclosed bad news, and therefore, there is no actionable corrective disclosure. Thus, defendants who succeed at concealing fraud are most likely to be insulated from liability. That is the exact opposite result sought to be achieved by the federal securities laws. We will have to wait to see if the Ninth Circuit agrees.


Leakage Theory is No Longer Just a Theory

Attorney: Michael J. Wernke
Pomerantz Monitor September/October 2015

It all started ten years ago with a question posed by  Justice Stevens during oral arguments in Dura Pharm., Inc. v. Broudo: “What if the information leaks out and there’s no specific one disclosure that does it all and the stock gradually declines over a period of six months?” Until last month, this question remained in the “what if” category of securities fraud jurisprudence. We now have an answer. In Dura, the Supreme Court held that a plaintiff in a securities fraud action must plead the element of loss causation, i.e. that the company’s stock price declined once the truth was revealed through a corrective disclosure. At trial, the plaintiff must ultimately prove that the decline in stock price was a result of the fraud – not market, industry or company-specific nonfraud factors. Since Dura, courts have universally held that loss causation can be established even if the truth is revealed through multiple “partial” corrective disclosures that drove the stock price down.

Courts have also acknowledged that, in theory, a company’s stock price could decline as a result of the truth “leaking” into the market without any actual disclosures of the fraud. For example, the stock price may move because insiders traded on the inside fraud related information prior to a disclosure, or because investors gradually lost confidence in the company’s previous misrepresentations even though the truth was not yet officially disclosed. However, in practice, courts have until now required plaintiffs to connect any decline in stock price to an identifiable “corrective” disclosure. 

The Seventh Circuit’s June 21, 2015 decision in Glickenhaus & Co. v. Household InternationalInc. has lifted that restriction, creating the possibility that investors may recover losses resulting from the gradual decline in a company’s stock price that is not directly connected to any corrective disclosure, but which can be attributed indirectly to the unraveling of the underlying fraud. 

In Household, the defendants appealed to the Seventh Circuit a jury verdict finding them liable for securities fraud on the basis that the causation/damages model adopted by the jury failed to establish loss causation. The plaintiffs had presented two models to the jury. The first, a “Specific Disclosure Model,” identified fourteen partial corrective disclosures that revealed the truth to the market and calculated the price declines that followed within the next day, removing price movements attributable to market and industry factors. This model determined that disclosure of the fraud led directly to investor losses of $7.97 per share. The second analysis, the “Leakage Model,” attributed to the fraud all the price declines during the year-long period of partial disclosures, except for declines caused by market or industry factors. Using this model, plaintiffs calculated that losses per share were $23.94. The jury adopted the Leakage Model and damages were ultimately determined to be $2.46 billion.

In their appeal, the defendants argued that the Leakage Model was flawed because it included price declines that did not immediately follow any of the partial disclosures of the fraud. While the Leakage Model eliminated market and industry factors, it did not identify and eliminate the effect of company-specific, nonfraud news on the stock price, which may have contributed to the decline in stock price during the periods between the fourteen partial corrective disclosures. Instead, plaintiff’s expert testified in general terms that he considered the issue but was unable to conclude that non-fraud news would have altered the analysis. The question before the court was whether that was enough or whether the model itself must fully account
for the possibility that company-specific, nonfraud factors affected the stock price.

The court refused to answer simply “yes” or “no,” as doing so would create an unfair advantage for plaintiffs or defendants. Accepting the defendants’ position would likely doom the leakage theory because it may be “very difficult, if not impossible,” for any statistical model to separate damage caused by “leakage” from damage caused by release of company-specific news unrelated to the fraud. On the other hand, if it’s enough for an expert to offer a conclusory opinion that no company-specific, nonfraud related information affected the stock price, then plaintiffs may be able to easily evade their burden of proving that the loss for which they seek recovery was a result only of the alleged fraud.

The court chose a middle ground, creating burden-shifting process to be used at trial. It held that if the plaintiffs’ expert testifies in a nonconclusory fashion that no company-specific, nonfraud related information contributed to the decline in stock price, then the burden shifts to the defendants to identify some significant, company-specific, nonfraud related information
that could have affected the stock price. If the defendants can, then the burden shifts back to the plaintiffs to account for that specific information or provide a model that doesn’t suffer from the same problem. Significantly, the court stated that one solution for the plaintiffs would be to simply exclude from the model’s calculation any stock price movements directly related to the company-specific nonfraud information identified by the defendants. 

While the defendants won the battle – the case was remanded to the trial court – investors may have won the war. Plaintiffs’ recoveries in a securities fraud action are no longer limited to stock price declines immediately following specific disclosures of the fraud. Moreover, the
Seventh Circuit provided a clear roadmap for the creation and use of a leakage model that can withstand judicial scrutiny (at least in the Seventh Circuit). 

Notably, this decision came only a year after the Supreme Court’s decision in Halliburton II, which dialed back the more rigid views of market efficiency which had previously been employed by many of the lower courts, and installed a similar burden-shifting process for that analysis. The Seventh Circuit’s decision could be viewed as a road marker in a forming trend of courts taking a more practical view of how securities markets function and investors’ burdens in proving their losses from frauds.


Ninth Circuit Refuses to Follow Second Circuit's Insider Trading Decision

Attorney: Leigh Handelman Smollar
Pomerantz Monitor July/August 2015

In a controversial decision written by Manhattan U.S. District Judge Rakoff, sitting by designation, the 9th Circuit recently upheld an insider trading conviction and, in the process, refused to follow the standard established by the Second Circuit in its Newman opinion decided in 2014. That case made it more difficult to convict recipients of inside information (“tippees”) by requiring the govern-ment to show that the tippee was not only aware that the information came from a corporate insider, but also that he or she knew that the insider (the “tipper”) had received a tangible benefit in exchange for leaking the information, a benefit that was “objective, consequential and rep-resents at least a potential gain of a pecuniary or similarly valuable nature.” Newman rejects the theory that leaking to enhance a personal, family or business relationship satisfies the personal benefit requirement. Several guilty pleas obtained from tippees were overturned based on the decision.

The Newman case involved tippees who were several layers removed from the tipper’s original disclosure of inside information. When inside information is passed around an investment firm, for example, it may be difficult to prove that someone way down the information food chain was aware of the original source of the leak and that the tipper had received a personal benefit.

In U.S. v. Salman, decided July 6, 2015, the 9th Circuit has refused to follow Newman. In that case Salman’s brother- in-law leaked inside information to his own brother, who in turn, shared that information with Salman. The evidence at trial showed that Salman knew that his brother-in-law was the original source of the inside information.

But the evidence also showed that Salman did not know about any tangible economic benefit received by his brother-in-law in exchange for leaking the information.

But the 9th Circuit disagreed with the Second Circuit in Newman and affirmed the conviction anyway. The court held that the “personal benefit” requirement did not require that the tipper receive a financial quid pro quo. Instead, it held that it was enough that Salman “could readily have inferred [his brother-in-law’s] intent to benefit [his brother].” In declining to follow Newman, the court noted that if the standard required that the tipper received something more than the chance to benefit a close family member, a tipper could provide material non- public information to family members to trade on as long as the tipper “asked for no tangible compensation in return.”

Are Airlines Conspiring to Keep Prices High?

Attorney: Jayne A. Goldstein
Pomerantz Monitor July/August 2015

Since 1978, when Congress enacted the Airline Deregulation Act (“ADA”), the domestic airline industry has been deregulated. The Act did away with govern-mental control over fares, routes and market entry of new airlines, leaving market forces to dictate these aspects of the industry, and causing the airlines to compete over fares, routes and seats.

Times have changed. Since 2005, with the merger of US Airways and America West, the airline industry has been significantly consolidated. The Delta and Northwest merger followed in 2008, the United and Continental merger in 2010, and the Southwest and AirTran merger in 2011. Most recently, American and US Airways merged in 2013, creating the biggest airline in the world. Today, American, United, Southwest and Delta account for over 80% of the domestic airline market. So much concentration of market power makes it easier for the few remaining behemoth competitors to rig the market.

On June 11, 2015, the New York Times published the article, “‘Discipline’ for Airlines, Pain for Fliers,” in which it revealed that airlines had discussed maintaining “discipline” at a recent industry conference at the International Air Transport Association (“IATA”) held in Miami earlier that month. “Discipline” in this context is a euphemism for limiting flights and seats, raising prices and increasing profit margins. At the meeting, Delta Airline’s president, Ed Bastian, stated that Delta was “continuing with the discipline that the market place is expecting.” Also at this meeting, American Airlines’ chief, Dough Parker, stated that the airlines had learned their lessons from past price wars: “I think everybody in the industry understands that,” he told Reuters. In May 2015, Defendant Southwest’s chief executive, Gary C. Kelly, had considered breaking ranks and announced that Southwest would expand capacity in 2015-2016 by as much as 8 percent. However, after coming under fire at the IATA conference in June 2015, Mr. Kelly changed his position, stating, “We have taken steps this week to begin pulling down our second half 2015 to manage our 2015 capacity growth, year-over- year, to approximately 7 percent.”

The “discipline” is paying off; it is projected that airline industry profits will more than double in 2015, to a record nearly $30 billion. When airlines (or other companies) collude to restrict capacity in their routes and seats, they are subject to violating the antitrust laws. When companies are not competing in the marketplace, consumers foot the bill with high prices.

Several senators called for a federal investigation of U.S. airline prices, which have not come down, despite the fact that the price of jet fuel has fallen dramatically. In mid-June, Senator Richard Blumenthal (D-Conn.) asked the Department of Justice to investigate possible collusion and anti-competitive behavior by U.S. airline companies following the meeting of top executives at the IATA annual conference. It appears that the Department of Justice heard the senators’ requests, and is now investigating whether American, United, Southwest and Delta colluded to restrain capacity and drive up fares, an antitrust violation. On July 1, 2015, the airlines confirmed that the DOJ had requested information from them about capacity and other matters.

In the wake of alleged collusion among the airlines, numerous lawsuits have been filed. On July 10, 2015, Pomerantz instituted an antitrust class action on behalf of direct purchasers of airline tickets against American, United, Southwest and Delta. The case is pending in the Northern District of Illinois.


Delaware Ban on Fee-Shifting ByLaws Signed Into Law

Attorney: Samuel J. Adams
Pomerantz Monitor July/August 2015

In a victory for shareholder rights, Delaware’s Governor recently signed into law a bill that prohibits fee-shifting bylaws for Delaware-incorporated publicly traded corporations. The bill was passed in response to a growing number of Delaware stock corporations that had recently begun adopting fee-shifting provisions that sought to pass defense costs on to unsuccessful shareholder plaintiffs or, in some cases, even plaintiffs that were only partly successful in a lawsuit for breach-es of fiduciary duty or other similar claims. Because shareholder plaintiffs – like plaintiffs in all other kinds of actions – almost never prevail on all counts asserted in a complaint, the specter of crushing financial liability from such bylaws threatened to choke off almost all shareholder litigation, regardless of the merits.

The increasing number of fee-shifting bylaws adopted by Delaware corporations stemmed from the Delaware Supreme Court’s decision last year in ATP Tour v. Deutscher Tennis Bund, which upheld a fee-shifting bylaw enacted by a private company. In that decision, the court held that a private Delaware corporation may adopt a bylaw which shifts all litigation expenses to a member plaintiff who does not obtain “a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought.” While the ATP court did not weigh in on whether such a bylaw would be permissible in the context of a public company, some public corporate boards of directors sensed an opening. With dozens of public companies adopting such fee-shifting provisions, action was needed by either the legislature or the judiciary in order to clarify the enforceability of these bylaws.

Earlier this year, prior to Delaware’s enactment of the fee-shifting bylaw prohibition, Pomerantz was on the vanguard of the fight against fee-shifting provisions in a case of first impression in Strougo v. Hollander. In that opinion, the first to address fee-shifting provisions following ATP, the Delaware Court of Chancery found that a fee-shifting bylaw was inapplicable to a share-holder plaintiff and the class where the bylaw was adopted after a plaintiff had been forcibly cashed out through a reverse stock split. While not explicitly ruling on the broader issue of the applicability of fee-shifting bylaws generally to public corporations, Chancellor Bouchard found that the bylaw in that instance did not apply to the shareholder plaintiff both because the bylaw was adopted after the plaintiff had been forcibly cashed out as a shareholder, and also because Delaware law does not authorize bylaws that regulate the rights or powers of a stockholder whose equity interest in a corporation had been eliminated before the bylaw was adopted.

In enacting the bill, the Delaware legislature recognized the chilling effect that fee-shifting bylaws would likely have on the ability of shareholders to voice certain challenges to corporations in court. Because many public companies chose to incorporate in Delaware, the Delaware courts and judiciary have a substantial influence on corporate governance. The synopsis of the bill itself states that the prohibition on fee-shifting provisions was enacted “in order to preserve the efficacy of the enforcement of fiduciary duties in stock corporations.” While many believed that the Delaware courts would have ultimately invalidated fee-shifting bylaws for public companies, the bill obviated the need for the courts to weigh in on the issue. As a consequence, shareholder plaintiffs can seek to hold corporate fiduciaries accountable without the risk of liability to corporate defendants for potentially millions of dollars in attorneys’ fees.

In a compromise, the recently-enacted bill also affirmed the enforceability of forum selection bylaws which seek to dictate the exclusive court in which plaintiffs may file certain types of shareholder litigation, such as those asserting claims for breaches of fiduciary duty. In many cases, shareholder plaintiff can elect to file such litigation in either a public company’s state of incorporation or the state of a corporation’s head- quarters. For Delaware public companies that wish to limit such litigation to a particular venue, the Delaware legislature clarified that such forum selection clauses are enforceable, so long as Delaware is selected as the exclusive forum for such litigation.

Our Walter Case Survives Motion To Dismiss

Attorney: Murielle Stevens Walsh
Pomerantz Monitor July/August 2015

Judge Ungaro of the U.S. District Court for the Southern District of Florida has recently denied the motion to dismiss our complaint against Walter Investment Management and several of its officers.

The case alleges that the defendants misrepresented that the company had sound internal controls and was in compliance with federal regulations regarding mortgage servicing, when in fact one of the company’s primary subsidiaries, Green Tree Servicing, had engaged in rampant violations of federal consumer laws. Walter’s stock price declined when the company revealed that the government was investigating it for these violations. Defendants initially moved to dismiss our original complaint, arguing that the disclosure of the investigation was not enough to establish loss causation, a requirement for a securities fraud claim. The court agreed, because under applicable 11th Circuit standards, the disclosure of a government investigation and possible government action, standing alone, were not enough to establish loss causation. The theory is that an investigation means that there is merely some possibility that violations had occurred, which the court held is not certain enough to amount to a “corrective disclosure” that the company’s statements about legal compliance were wrong. The court did, however, grant us leave to amend the complaint.

Our second amended complaint included the new allegation that the government announced that it had decided to bring an enforcement action against the company to seek injunctive relief and fines. Importantly, analysts factored this development into their price target for Walter stock. We included these facts in our amended complaint; and the judge found that this disclosure was sufficient to establish loss causation – even though the initiation of a lawsuit by itself is not tantamount to a “corrective disclosure” either, because the company still could prevail at trial. But the Court held that the bringing of the government action moved the potential losses much closer to reality.

Ultimately, the company settled the government case, agreeing to injunctive relief and the payment of fines. 

Whether disclosure of an investigation satisfies the “loss causation” requirement is a contentious issue in securities fraud litigation. Typically, it is such disclosures that actually trigger most of the losses; after that point, the market factors into the market price much of the risk of eventual litigation and its consequences.



Attorneys: Jessica N. Dell and H. Adam Prussin
Pomerantz Monitor July/August 2015

In March, the Supreme Court, in a case called Omnicare, tackled the issue of when statements of opinion that appear in a registration statement can violate Section 11 of the Securities Act. Section 11 creates a private right of action for investors who purchased shares in an initial public offering when the registration statement contained materially false or misleading information. Unlike theantifraud provisions of the Exchange Act, Section 11 does not require that the investor show that the issuer, or the directors who signed the registration statement, had a culpable state of mind. If the registration statement was wrong, defendants are liable. The company is subject to strict liability; the directors can escape liability only if they can establish an affirmative defense.

In Omnicare the registration statement expressed the belief that the rebates Omnicare was receiving from suppliers were legal. In its decision below, the Sixth Circuit had held that under Section 11 a statement of opinion or belief can violate Section 11 if the opinion or belief turned out to be wrong – even if the issuer and its directors sincerely believed it at the time.

The Supreme Court rejected that view, holding that statements of opinion or belief are not “misstatements of fact” for purposes of Section 11. “Most important, a statement of fact (‘the coffee is hot’) expresses certainty about a thing, whereas a statement of opinion (‘I think the coffee is hot’) does not.” Because statements of opinion do not convey certainty about the subject, the Court rejected the contention that an expression of opinion or belief can be a misstatement of fact simply because it turned out to be wrong. Instead, the Court held that beliefs or opinions can be misstatements of fact only if the issuer did not really believe them at the time. While opinions themselves may be subjective, whether one holds them or not is an objective fact. In Omnicare, defendants clearly believed what they had said, so there was no misstatement of fact.

But the Court’s opinion did not stop there. It also held that a reasonable investor is entitled to assume that the issuer had a basis for the opinion or belief it is conveying. For example, if the issuer says that it believes that certain of its business practices are in compliance with applicable law, as Omnicare did here, it would also have to disclose whether it had formed that belief without consulting a lawyer, or if its lawyers had given contrary advice. Omissions can render those statements misleading if “the investor … identifies particular (and material) facts going to the basis for the issuer’s opinion—facts about the inquiry the issuer did or did not conduct or the knowledge it did or did not have—whose omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context.”

This issue is going to be the focus of future litigation over Section 11 liability for statements of opinion or belief. What type of foundation can investors reasonably assume a company has for such statements, and what qualifies as a material fact that had to be disclosed because it might undermine that assumed foundation? Time will tell.


Petrobras: The Whole Barrel is Tainted, Not Just Four Rotten Apples

Attorney: Justin Nematzadeh
Pomerantz Monitor July/August 2015

On July 9, 2015, Pomerantz won a significant victory for investors against Petrobras, the Brazilian energy giant, and four of its senior executives, when the district court rejected defendants’ motion to dismiss the action. For years Petrobras has been embroiled in a massive scandal, as prosecutors there have been pursuing the largest corruption investigation in that country’s history.In 2009 Petrobras had a market capitalization of $310 billion; now, since this massive scheme came to light, itis down to $55 billion. As the Monitor previously reported, the scheme involved overcharging Petrobras for goods and services, with the excessive payments being used to bribe a host of Petrobras and government officials.This scheme was allegedly orchestrated by four Petrobras officials, all of whom are defendants in our action.

The heart of the company’s motion was its contention that scienter, or knowledge, of the wrongdoing was limited to four “rogue” officers of the company, and that their knowledge cannot be “imputed,” or attributed, to the company, under the so-called “adverse interest” theory. Normally, a company is deemed to know what its senior executives know; but if those executives are acting for their own personal interests, and contrary to the interests of their company, they are acting outside the scope of their employment and their knowledge is not imputed to the company. Here, defendants argued that the officers’conduct was adverse to the company’s interests because the scheme diverted cash from the company, as a result of the overcharges the company paid, and into the pockets of the four individual defendants and various corrupt politicians and other conspirators. In addition, by artificially inflating asset values on Petrobras’ balance sheet,defendants argued that the individuals harmed the company by causing it to pay excessive prices that were reflected in the carrying value of those assets.

But, as senior Pomerantz partner Jeremy Lieberman explained to the Court at the hearing on the motion to dismiss, knowledge of the scheme was not limited to the four “rotten apples,” but was, in fact, widely disseminated in the company. Most notably, perhaps, he highlighted evidence showing that the Petrobras board was aware of the over billing scheme. Moreover, he argued that the adverse interest exception applies only when the company receives no benefit what-soever from the misconduct. Here,in contrast, the beneficiaries of the scheme were officials of the Brazilian government – which owns 51% of Petrobras’ stock. Moreover, by failing to correct the company’s fraudulent financial statements,the defendants were benefiting Petrobras by avoiding a massive write-down of the company’s assets.

Defendants also argued that the scheme was immaterial because its payments to contractors were inflated by only 3% and that the four conspirators received kickbacks amounting to a small portion of this 3%. As a result, when the scheme was disclosed Petrobras was forced to write off only $2.5 billion of property, plant and equipment on its balance sheet, about 8% of the total assets. In fact, however, our well-founded allegations showed that Petrobras was over billed by about 20%, not 3%, and that the $2.5 billion write-down reflected only a small fraction of the actual impact of the fraudulent scheme.


Pomerantz Shatters the Glass Ceiling

Pomerantz Monitor, May/June 2015

 Pomerantz LLP is once again at the vanguard of the legal field. In a recent report, Law 360 has ranked the firm No. 1 in Top Law Firms for Women: Class Action Securities Firms. Pomerantz is proud to boast a 40% rate of female partners, 40% rate of female Of Counsel, and a 50% rate of female associates. These numbers put Pomerantz near the head of women overall in law firms in the United States, and at the forefront of women in class action securities firms in particular. 

Managing Partner Marc I. Gross shared his thoughts on this distinction, stating, “Pomerantz is proud that its efforts to maintain a diversified staff of attorneys and partners has been so successful. We hope other firms will follow.”

Pomerantz is no stranger to cutting edge accomplishments in the legal field, consistently finding new and innovative ways to fight for our clients’ rights; we are proud of this latest recognition of our success. At a time when the gender gap in America’s workforce is a source of national controversy, Pomerantz strongly stands by our hiring practices, which ensure the best attorneys are chosen for the job of representing our clients. 

Partner Murielle Steven Walsh says, “As a young associate at Pomerantz, I was mentored by a women partner. That experience had a positive impact on my development as an attorney.” Ms. Steven Walsh has prosecuted highly successful securities class action and corporate governance cases, and has argued, and won, cases before the Second Court of Appeals. 

Among recent accolades for Pomerantz attorneys, Partner Jayne Goldstein, who heads Pomerantz’s Florida office, was featured in a recent Law 360 article, “The Female Attorneys You Admire”; and Tamar A. Weinrib, Of Counsel, was chosen as a New York Metro Rising Star in 2014. 

Pomerantz looks forward to keep pushing the envelope in this arena and others as we continue the legacy our founder, Abe Pomerantz, began almost 80 years ago.  


Subprime Redux – Will Securitized Subprime Auto Loans Cause the Next Financial Crisis?



Much of the blame for the 2008 financial crisis belongs to subprime mortgage lending - making loans to people who had difficulty maintaining the repayment schedule, and then bundling those loans into securities and selling them to investors. Now some observers are concerned that a recent jump in subprime auto loans could also mean disaster for markets.

Right after the financial collapse auto loans almost dried up completely, threatening the auto industry. But since then the subprime auto loan market has sprung back to life, as millions of Americans with tarnished credit easily obtained auto loans. According to the Federal Reserve Bank of New York, the number of auto loans made to borrowers with credit scores below 660 has nearly doubled since 2009 – a much greater increase than in any other loan type. Some sources place the increase at an even greater figure. According to the New York Times, in the five years since the immediate aftermath of the financial crisis, roughly one in four new auto loans last year went to borrowers considered subprime. Figures from two consumer credit tracking firms, Experian and TransUnion, show record amounts of auto loans on the books at the end of 2014. Not only were drivers buying more cars than any year since 2006, but they were spending more on each car they bought. 

The subprime auto loan market has some characteristics in common with the mortgage loan market. Risky sub-prime auto loans are being bundled into complex bonds and then sold by banks to insurance companies, mutual funds and public pension funds, just like subprime mortgage loans were in the late 2000s. Also, many subprime auto lenders are loosening credit standards and focusing on the riskiest borrowers. Recently, there have been a number of claims of abuse or outright fraud, as some lenders are accused of forging data on their customers’ loan applications, or committing borrowers into loans with terms substantially different than what had been negotiated. But most are hesitant to call the rise in subprime auto lending a bubble. 

Luckily, the overall auto loan market is comparatively small -- $900 billion -- compared to $8 trillion of mortgage loans. Subprime currently makes up about 30% of overall car loans. A higher rate of auto loan defaults probably won’t cause a market decline on a scale comparable to the mortgage crisis. Second, according to some economists, borrowers tend to make car payments a higher priority than mortgage payments or credit card bills, since they need their cars to get to work, school and for many other daily necessities.

Still, the rise in subprime auto loans has caught the attention of regulators. This past summer, federal prosecutors began a civil investigation into the packaging and selling of questionable auto loans to investors. The probe is focusing on whether checks and standards were neglected as the subprime auto loan market surged and whether some borrowers’ loan applications had false information about income and employment. In addition, investigators want to know how the loans, which were pooled and assembled into securities, were represented to investors and whether the lenders fully disclosed to investors the credit-worthiness of the borrowers. 

One company that has been targeted during the investigation is the finance subsidiary of General Motors G.M. Financial Company. In August, the company disclosed that it had received a subpoena from the U.S. Department of Justice directing it to produce certain documents related to its origination and securitization of subprime automobile loan contracts since 2007. The United States attorney for the Southern District of New York is also looking into G.M. Financial, as well as other auto finance companies. 

G.M. Financial, has been one of the largest sellers of auto loan backed bonds, selling a total of $65 billion in securities. This year, G.M. Financial sold investors roughly $730 million in bonds made up of auto loans that carried an average annual interest rate of about 13 percent. Standard & Poor’s gave most of the bonds an AAA rating, but given what we know now about the ratings agencies, that rating is highly suspect. 

With total loans expected to cross the $1 trillion mark by the end of this year or early in 2016, this issue won’t disappear anytime soon. So far, the rise in subprime auto lending hasn’t slowed investors’ appetite for auto loan backed bonds, and most analysts don’t expect a rise in borrower defaults to cause a catastrophic market meltdown like the subprime mortgage crisis. On the regulatory front, aside from a settlement by one auto loan finance company over accusations that it increased the cost of auto loans for minority borrowers, there haven’t been any formal charges brought. However, regulators are clearly taking a closer look and should charges be brought in the future, it could dramatically change the way investors feel about buying securities back by subprime auto loans.

Pomerantz Takes a Bite Out of For-Profit College Scheme in Corinthian Colleges


On April 22, 2015, in Erickson v. Corinthian Colleges, Inc., Pomerantz scored a significant victory for investors against the much-criticized and poorly regulated for-profit college industry, when Chief Judge George King of the Northern District of California denied the defendant’s motion to dismiss the action. 

Corinthian Colleges was historically one of the largest for-profit college systems in the country, and when our firm filed an amended complaint in the case, the company was operating 111 campuses in 25 states. For-profit colleges are big business, making most of their profits from federal student aid programs. However, many for-profit colleges have come under fire in recent years for their deceptive practices (especially for their promises to adult students regarding the potential for gainful employment upon graduation), leading President Obama to implement new federal student loan and job placement guidelines. 

Our amended complaint alleges that Corinthian was misrepresenting its job placement rates, compliance with applicable regulations, and enrollment statistics. Our complaint relied on a host of sources: in addition to testimony from 15 confidential witnesses from all over the company, we also relied on documentary evidence cited in the California Attorney General’s complaint against the company (showing that job placement data was manipulated, errors were rampant, and placements were not verified consistently) and a Congressional report criticizing the for-profit college industry (especially with respect to Corinthian’s practice of constantly “churning” its student body to keep up enrollment rates, by enrolling massive numbers of new students each year to hide the fact that so many previous enrollees had dropped out after a short time). While the Court dismissed the regulatory compliance statements as too vague to be actionable, it upheld the job placement rate and enrollment statistic misrepresentations. 

The Court put all our allegations under a microscope and determined that the specific facts we alleged supported our claims that many of defendants’ public statements were false, and that the senior executive defendants knew it.

In addition, the Court agreed that we sufficiently alleged loss causation because public disclosures of the Attorney General’s lawsuit and the Congressional report raising these allegations led directly to significant drops in the market price for Corinthian’s securities.

This victory is especially noteworthy because Judge King has dismissed two prior lawsuits against Corinthian with similar allegations and because pleading loss causation in the Ninth Circuit has become particularly difficult in the wake of a recent decision by that court in another case.

How a Landmark Securities Case Helped Certify an Antitrust Class


Pomerantz currently acts as co-lead counsel for a class of third party payors and consumers in the antitrust action involving heartburn medication Nexium. The plaintiffs in this action allege that the branded dug company, AstraZeneca, and several generic drug makers violated antitrust laws by entering into agreements to delay entry of a generic version of Nexium. This type of case is often referred to as a pay-for-delay case where because the manufacturer of the brand name drug typically pays generic drug manufacturers to delay their entry to the market with a generic version of the brand drug. Such agreements have an obvious anti-competitive effect. 

These cases have been a hot topic in the legal community because the Supreme Court recently reviewed these types of cases and established a standard for analysis of such agreements. In June, 2013, the Supreme Court, in FTC v. Actavis, ruled that such pay-to-delay arrangements can run afoul of antitrust laws under a rule of reason analysis. The Court held that if plaintiffs could show that the brand name manufacturer made a large and unjustified payment to the generic drug makers that could be a violation of the antitrust laws. 

In late 2013, the District of Massachusetts granted plaintiffs’ motion for class certification of our Nexium case, finding that the “plaintiffs had adequately shown that (1) “prices [during the class period] for esomeprazole [the chemical name for Nexium] continued [to be] artificially high as a result of the defendants’ reverse payment agreements,” and (2) “that all class members have been exposed to purchasing or paying for [the drug] at a supracompetitive price.” The District Court also concluded that even though some members of the class did not suffer injury as a result of the alleged antitrust violation that was irrelevant because the vast majority of class members had been injured. 

Defendant appealed the District Court’s class certification ruling to the United States First Circuit of Appeals on the sole ground that the class included members who were not injured by the agreements. Defendants specifically gave the example that some individual consumers would continue to purchase branded Nexium for the same price even after generic entry – so called brand loyalists. Defendants relied on the First Circuit’s previous decision in In re New Motor Vehicles Canadian Export Antitrust Litigation, arguing that to obtain class certification Plaintiffs must show that, “each class member was harmed by defendant’s practice.” 

The First Circuit ultimately rejected that argument, concluding that “class certification is permissible even if the class includes a de minimis number of uninjured parties.” On the topic of the requirement that all class members be harmed the court stated, “[t]o the extent that New Motor Vehicles is read to impose such a requirement, it has been overruled by the Supreme Court’s Halliburton decision. But, in fact, New Motor Vehicles imposes no such requirement. 

In Halliburton, the Supreme Court addressed the treatment of potentially uninjured class members. Halliburton was a landmark securities case that reviewed the presumption of reliance in securities cases. Halliburton found that a securities class can presume that the investors relied on defendant’s misrepresentation when deciding to purchase or sell a stock rather than prove direct reliance of defendant’s misrepresentations for each individual class member and defendants can rebut this presumption. The Supreme Court stated, “[w]hile [the rebuttal] has the effect of leaving individualized questions of reliance in the case, there is no reason to think that these questions will overwhelm common ones and render class certification inappropriate under Rule 23(b)(3).” As a result, the First Circuit in In re Nexium, found that because Halliburton “contemplated that a class with uninjured members could be certified if the presence of a de minimis number of uninjured members did not overwhelm the common issues for the class,” the Nexium class can also be certified despite a de minimis number of uninjured members.  

Our Securities Fraud Case Survives Barclays’ Motion to Dismiss


Pomerantz largely defeated defendants’ motion to dismiss our complaint against Barclays bank and several of its officers and directors. Our action accuses Barclays of making false and misleading statements about the operations of its “dark pool.” A “dark pool” is an alternative trading system that does not display quotations or subscribers’ orders to anyone other than to employees of the system. Dark pools were first established to avoid large block orders from influencing financial markets and to ensure trading privacy. Trading in dark pools is conducted away from public exchanges and the trades remain anonymous, lowering the risk that the trade will move the market price. About 15% of U.S. equity-trading volume is transacted in dark pools.

Precisely because these trades are conducted “in the dark,” institutional investors trading in these venues rely upon the honesty and integrity of their brokers and the dark pool operators to act in their clients’ best interest.

If given information about impending customer trades, high frequency traders in the dark pools can trade ahead of those customers and then profit at their expense by reselling the shares to complete the order. Studies seem to show that, as of 2009, high frequency trading accounted for 60%-73% of all U.S. equity trading volume. Keeping such traders away from the dark pools could help protect other investors from their front-running and other predatory trading practices.

After a series of scandals, and in particular disclosure of its manipulation of the LIBOR benchmark interest rates, Barclays commissioned an independent investigation of itself. As a result of the findings, it publicly pledged, among other things, to act with transparency and to impose strict controls over trading in its dark pool. These pledges, it turns out, were a sham. Barclays actually embarked instead on a campaign to make itself the largest dark pool in the industry, by hook or by crook.

An investigation by the New York Attorney General revealed that, in order to grow the dark pool, Barclays increased the number of orders that it, acting as broker, executed in the pool. This required that Barclays route more client orders into the dark pool, and ensure that there was sufficient liquidity to fill those orders. To convince the market of the safety of trading in its dark pool, Barclays represented that it would monitor the “toxicity” of the trading behavior in its dark pool and would “hold traders accountable if their trading was aggressive, predatory, or toxic.” Such “toxic” trading activity included high frequency trading, which it pledged to keep out of its dark pool.

But these alleged controls were illusory. One former director explained that Barclays “purports to have a toxicity framework that will protect you when everybody knows internally that [they don’t]”. Another former director described these controls as “a scam.” Our complaint alleged that Barclays representations about establishing a monitoring program to eliminate “toxic” trading from the dark pool were misleading because Barclays did not disclose that it did not eliminate traders who behaved in a predatory manner, did not restrict predatory traders access to the dark pool, did not monitor client orders continuously, and did not monitor some trading activity in the pool at all. In fact, plaintiffs allege, Barclays encouraged predatory traders to enter the dark pool.

The court’s decision is significant because of its emphasis on the importance to investors of corporate integrity. Barclays' motion to dismiss relied heavily on the contention that its misrepresentations about the dark pool were immaterial to investors because revenues from the dark pool were far less than 5% of the company’s total revenues. This figure is a statistical benchmark often used to assess materiality. In fact, revenues from the dark pool division contributed only 0.1% of Barclays total revenues. The court rejected Defendants’ myopic view of materiality and found that the misrepresentations went to the heart of the firm’s integrity and reputation, which had been jeopardized by its past well-publicized transgressions. The court’s decision means that misrepresentations about management’s integrity can be actionable even if the amounts of money involved in these transgressions falls below a presumptive numerical threshold. 

The court also held that Defendant William White, the Head of Barclays’ Equities Electronic Trading, was a sufficiently high-ranking official that his intent to defraud could be imputed to the company itself. The court explained that “there is strong circumstantial evidence of conscious misbehavior or recklessness on [his]part. “Not only was White the source of many of the allegedly false allegations about [the dark pool] but he was the head of Equities Electronic Trading at Barclays, “the driving force behind the Company’s goal to be the number one dark pool,” and he “held himself [out] to the public as intimately knowledgeable about LX’s functions and purported transparency.” 



Product Hopping, Big Pharma and the High Cost of Prescription Drugs


The Monitor has been reporting for years on so-called “pay for delay” schemes used by brand name drug manufacturers to stave off generic competition. Such schemes are subject to antitrust challenge as unlawful restraints of trade, and the Firm has been pursuing such cases vigorously.

Now there is a new scheme, called “product hopping.” In the classic version of this anticompetitive scheme, brand name manufacturers come out with a “new” version of their drug and stop production of the previous version altogether, forcing everyone taking that drug to switch to the new version, even if isn’t any better. The newly introduced drug likely has only minor changes from the existing one (e.g., from tablet to capsule; from immediate to extended release) and does not provide any improvement in its therapeutic benefits. But, since there are no generic competitors for the new version, the brand manufacturer can continue to reap monopoly profits for years to come. By the time a generic of the original formula enters the market, there is no longer a demand for the original brand formula, because it has been discontinued. State laws that require generic substitution do not apply because the new brand drug is slightly different that the original. As a result of a successful product hopping scheme, generic competition—which reduces brand drug prices by about 90%—will be eliminated.

The pushback is beginning against product hopping. Notably, a New York Federal District Court recently granted an injunction stopping a brand name pharmaceutical company, Actavis, from discontinuing sales of its popular Alzheimer drug Namenda IR. The court concluded that the move was an unlawful product hopping scheme intended to switch vulnerable Alzheimer’s patients from the existing Namenda formula, which will face generic competition in 2015, to a newer, slightly different formula, which will not have generic competition until 2029. By removing original Namenda from the market, Actavis would have forced Alzheimer’s patients to switch to the new drug, with all its attendant risks, and would eventually force them to pay billions of dollars more for the new brand name treatment.

New York Attorney General Eric T. Schneiderman successfully brought this antitrust case against Namenda’s manufacturer, Forrest Labs, (now owned by Actavis) alleging that the forced switch to a so-called new and improved version was nothing more than illegal attempt to maintain its $1.6 billion Namenda monopoly even after its patent expires. According to Schneiderman, “[a] drug company manipulating vulnerable patients and forcing physicians to alter treatment plans unnecessarily, simply to protect corporate profits, is unethical and illegal.” The federal district court agreed, although this decision is now on an expedited appeal before the United States Court of Appeals. Oral argument on the appeal is scheduled for April 13, 2015.

In the Namenda case, the brand drug company not only introduced a new once-a-day (extended release) capsule, but also announced that it intended to stop selling its original twice-a-day (instant release) tablet, which was soon to face generic competition. There is no therapeutic difference between the two formulations.

As another court defined the issue last year, “although the issue of product-hopping is relatively novel, what is clear from the case law is that simply introducing a new product on the market, whether it is a superior product or not, does not, by itself, constitute exclusionary [antitrust] conduct. The key question is whether the defendant combined the introduction of a new product with some other wrongful conduct, such that the comprehensive effect is likely to stymie competition, prevent consumer choice and reduce the market’s ambit.”

In particular, courts have increasingly found that where the brand drug company not only introduces a new drug version but also removes the original version of the drug from the market, it violates the antitrust laws. In cases involving the drugs Tricor and Doryx, the manufacturers introduced new versions of the drugs; stopped sales of the original versions; and removed unused inventory of the original formula from the market. In addition, in Tricor, the company changed the code for the original drug to ‘obsolete’ on an industry-wide database, which prevented pharmacies from filling Tricor prescriptions with a generic. In both cases, defendants’ exclusionary conduct restricted consumer choice. In the end, Tricor settled for in excess of $250 million, while Doryx is still pending.

More recently, In re Suboxone Antitrust Litig., allegations of another product hopping scheme were found sufficient to state an antitrust cause of action were the brand drug company not only introduced a new film version of the drug but made false safety claims about the original tablet version and threatened to remove the original version from the market. The court found that the “[t]he threatened removal of the tablets from the market in conjunction with the alleged fabricated safety concerns could plausibly coerce patients and doctors to switch from tablet to film.”

Pomerantz’s antitrust attorneys have been at the forefront of challenging anticompetitive conduct by pharmaceutical companies that seeks to block generic drugs, including product hopping schemes, pay-for-delay agreements and overall anticompetitive conspiracies that combine the two.

Is There Hope For Credit Rating Agencies?

ATTORNEY: Anna Karin F. Manalaysay

Anyone compiling a list of culprits in the U.S. subprime residential mortgage debacle of 2007-2008 would have to include the credit rating agencies at or near the top. Meant to provide investors with reliable information on the riskiness of various kinds of debt, the agencies have instead been accused of defrauding investors by giving triple-A ratings to mortgage-related securities so risky they were even considered doomed to fail by the banks that created them.

Why did this happen? Probably because the financial incentives for the ratings agencies have changed dramatically. In the past, credit rating agencies charged a subscription fee to subscribers to cover their rating activity. Then the practice changed, and the company or issuer being rated pays the fee. By switching to this business model, the ratings agencies assumed a crippling conflict of interest; for if they did not deliver high ratings regardless of the circumstances, issuers would shop around for a more compliant ratings agency the next time around.

The best-known credit rating agencies in the United States are Moody’s Investor Services, Standard and Poor’s, and Fitch. S&P issues nearly half of all credit ratings and together with Moody’s and Fitch, the so-called “Big Three” issue ninety-eight percent of the total ratings. On February 3, 2015, S&P agreed to pay $1.375 billion to settle lawsuits brought by the U.S. Department of Justice and 20 attorneys general concerning ratings S&P gave to certain mortgage securities just before the 2008 financial meltdown. So far, this has been the largest settlement involving a credit rating agency.

The press release issued by the Justice Department said the ratings at issue were given to residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDOs) during the period 2004 to 2007. RMBS are created when a bank or other financial institution pools together mortgage loans. CDOs pool together cash flow-generating assets and repackages this asset pool into discrete tranches that can be sold to investors.

The lawsuit filed by the Justice Department in 2013 alleged that S&P had engaged in a scheme to defraud investors by knowingly inflating the credit ratings it gave to RMBS and CDOs which resulted in substantial losses to investors and ultimately contributed to the worst financial crisis since the Great Depression. The Justice Department claimed that S&P’s rating decisions were not independent and objective as they were required to be but, rather, based in part, on its business concerns.

As a part of the settlement, S&P agreed to a statement of facts that contained an admission that its ratings for CDOs were partially made based on the effect they would have on S&P’s business relationship with issuers. It also admitted that, despite knowledge within the S&P organization in 2007 that many loans in RMBS transactions it was rating were delinquent and losses were probable, it continued to issue and confirm positive ratings.

As credit rating agencies were being blamed for feeding a subprime mortgage frenzy, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) in July 2010. Among its various provisions, Dodd-Frank outlined a series of broad reforms to the credit rating agencies market. Despite Dodd-Frank, however, some signs of trouble have re-emerged. In January 2015, for example, S&P paid nearly $80 million to settle accusations of the SEC that it orchestrated similar fraud in 2011, years after the financial crisis took place. S&P also agreed to take a one-year “timeout” from rating certain commercial mortgage investments at the heart of the case, an embarrassing blow to the rating agency. The pact is the SEC’s first-ever action against a major ratings firm.

The SEC has since issued new rules aimed to enhance governance, protect against conflicts of interest, and increase transparency. These rules, which went into effect January 1, 2015, require rating agencies such as S&P to: 

  • provide records of their internal control policies and rating methodology;
  •  prohibit their sales teams from participating in the rating process;
  • review, and revise if needed, ratings for companies that later hire one of the agency’s employees; and
  • file annual reports showing how the agencies monitor ratings, how ratings changed over time and whether evaluated companies eventually defaulted.

If a credit rating agency violates these rules, the SEC will suspend or revoke the agency’s registration — disciplinary action that may be effective in preventing further violations. However, while the regulations do attempt to keep rating activity under strict surveillance, they do not restructure the way rating agencies solicit business or receive payment. Thus, the inherent conflict of interest still exists since the agencies are paid by the same banks and companies they rate.

The SEC has thus far failed to maintain control and ensure rating agencies follow proper rating methodologies — the multiple accusations against S&P attest to these failures — but only the health of the future financial market will tell whether the recent regulations, coupled with the hefty consequences credit rating agencies such as S&P have had to face, will have a long-term stabilizing impact.


Pomerantz Wins Important Motion, Post-Halliburton

ATTORNEY: Joshua B. Silverman

When the Supreme Court issued its landmark decision in Halliburton v. Erica P. John Fund last summer, it did not give either side a total victory. Critically for investors, the Supreme Court reaffirmed the fraud-on-the-market presumption, which is necessary for class certification in most securities fraud actions. The presumption allows classwide proof of reliance, an element of Exchange Act claims, by demonstrating that the stock traded in an efficient market. In efficient markets, publicly-available information is incorporated into the stock price and traded on by all investors, so plaintiffs need not show that each class member actually heard or read the misrepresentations giving rise to the lawsuit. By reaffirming these principles, the Court ensured the continued viability of securities fraud class actions. However, at the same time, the decision offered defendants the ability to rebut the fraud-on-the-market presumption at the class certification stage by demonstrating that the alleged fraud did not affect the stock price.

Halliburton did not specify precisely how lower courts should determine market efficiency or lack of price impact. As lower courts begin to grapple with these issues, the early results are promising for investors. Thus far, district courts (and in one case, an intermediate court of appeals) have applied rational tests for both market efficiency and price impact, consistent with the principles set forth in Halliburton. 

The most important consequence of Halliburton may be to stabilize the law over what constitutes an efficient  market. In 1988, when the Supreme Court first recognized the fraud-on-the-market presumption, it declined to adopt any particular test for market efficiency. In the years that followed, most courts used the so-called “Cammer test,” which assessed, among other factors, trading volume, analyst coverage, and price movement following release
of important company-specific news. 

However, more recently defendants and their experts have urged courts to stack on top of the Cammer factors a litany of additional requirements lifted from the extreme end of academic debates about market efficiency. A significant minority of courts accepted these arguments, resulting in a patchwork of inconsistent standards. For example, some courts refused to certify cases involving stocks that moved in trends, theorizing that such trending—or serial correlation—was inconsistent with the belief of some academicians that efficient markets must be wholly unpredictable. Other courts looked to related options markets, holding that a lack of parity input and call options demonstrated constraints on arbitrage activity, and therefore showed market inefficiency. A few other courts suggested that impairments to arbitrage could also be found if the stock was difficult or expensive to sell short. 

Halliburton should put an end to these fringe academic tests. In its opinion, the Supreme Court emphasized that for purposes of the fraud-on-the-market presumption, market efficiency refers only to “the fairly modest premise that market professionals generally consider most publicly announced material statements about companies, thereby affecting stock market prices.” As one law professor explained, Halliburton demonstrates that “the efficiency question is not meant to be particularly rigorous.” District courts appear to get the message. Since Halliburton, no district court has cited serial correlation, lack of put-call parity, or short-lending costs as a basis for denying class certification in a securities fraud class action. 

Recently, Pomerantz won an important motion addressing the continued relevance of fringe academic market efficiency tests. In the Groupon securities litigation, where Pomerantz serves as lead counsel, defendants had argued that plaintiffs’ class certification expert was unreliable because he failed to conduct put-call parity and short lending fee analyses. After an extensive evidentiary hearing, the court sided with Pomerantz, holding that such tests were unnecessary because they addressed an extreme variation of market efficiency that “was squarely rejected by the Halliburton court.”

District courts have also applied reasonable, consistent tests when assessing the price impact defense recognized in Halliburton. They have thus far uniformly rejected defendants’ attempts to show lack of price impact by demonstrating that some or all of the misrepresentations did not move the stock at the time they were made. Instead, recognizing that misrepresentations are used to artificially maintain as well as boost share prices, courts in the Regions Financial, IntraLinks, and Best Buy litigations have all held that price impact can be found where the share price declines when the truth is revealed, even if the stock did not move at the time the false statements were issued. Best Buy has been appealed, so the Eighth Circuit will soon weigh in on the issue.

Defendants have been equally unsuccessful in attempts to persuade courts to disregard price movement, where it does occur, by claiming it was caused by something other than the alleged fraud. For example, in Catalyst Pharmaceuticals, the court rejected expert testimony that the truth was already known to the market. Such evidence, the court held, did not disprove price impact but instead addressed whether the omitted information was material, an issue reserved for the trier of fact. By strictly enforcing the Supreme Court’s requirement that defendants prove the absence of price impact instead of just proffering different explanations for price moves, lower courts have ensured that the exception to the fraud-on-the-market presumption did not swallow the rule.

Courts will continue to construe Halliburton in the coming months, particularly in the Best Buy appeal and Halliburton itself (where the issue of price impact was remanded to the district court). If they apply the measured reasoning seen in early cases, it will bring much-needed consistency and predictability to the class certification process.



Delaware Court Refuses to Apply Fee-Shifting Bylaw

ATTORNEY: Alla Zayenckik

Pomerantz achieved an important corporate governance victory for stockholders in March when Chancellor Bouchard of the Delaware Court of Chancery refused to apply a fee-shifting bylaw to plaintiff and the class in Strougo v. Hollander. Fee shifting bylaws impose on plaintiff shareholders and their counsel the defendants’ entire litigation costs, unless the action achieves a complete victory, including an award of the entire remedy sought in the action. Such bylaws, if widely adopted, would foreclose virtually all shareholder litigation, regardless of the merits. Last year, in a case called ATP, the Delaware Supreme Court held that such bylaws can be legally enforceable, at least in some circumstances.

In Strougo v. Hollander, a closely-watched test case, Chancellor Bouchard issued the first Delaware opinion to address fee-shifting bylaws since the Supreme Court’s ATP decision last year. The Chancellor found that defendants cannot bind plaintiff and the class to a fee-shifting bylaw adopted after plaintiff had been forcibly cashed out through a reverse stock split.

Accepting the arguments proffered by Pomerantz partner Gustavo F. Bruckner, head of Pomerantz’s corporate governance practice, the Court found the bylaw inapplicable as to plaintiff and the Class under both Delaware contract and corporate law. Chancellor Bouchard explained that the Bylaw does not apply for two related reasons: (i) the Board adopted the bylaw after plaintiff’s interest in the company was eliminated by the reverse stock split; and (ii) Delaware law does not authorize a bylaw that regulates the rights or powers of former stockholders who were no longer stockholders when the bylaw was adopted.

The Chancellor found that “[A] stockholder whose equity interest in the corporation is eliminated in a cash-out transaction is, after the effective time of that transaction, no longer a party to [the] flexible [corporate] contract. Instead, a stockholder whose equity is eliminated is equivalent to a non-party to the corporate contract, meaning that former stockholder is not subject to, or bound by, any bylaw amendments adopted after one’s interest in the corporation has been eliminated.”

The Chancellor also commented on the underlying merits of the case and the effect of fee-shifting bylaws. He wrote “the Bylaw in this case would have the effect of immunizing the Reverse Stock Split from judicial review because, in my view, no rational stockholder—and no rational plaintiff’s lawyer—would risk having to pay the Defendants’ uncapped attorneys’ fees to vindicate the rights of the Company’s minority stockholders, even though the Reverse Stock Split appears to be precisely the type of transaction that should be subject to Delaware’s most exacting standard of review to protect against fiduciary misconduct.”

Prior to the Chancellor’s ruling, on March 6, 2015, the Council of the Corporation Law Section of Delaware State Bar Association issued proposed amendments to the Delaware General Corporation Law that would ban fee-shifting provisions from a company’s bylaws or charter. If enacted, the amendments will become effective on August 1, 2015.

Pomerantz Appointed Lead Counsel in Historic Petrobras Securities Class Action

ATTORNEY: Francis P. McConville

Pomerantz will take the helm on a consolidated group of securities class actions over revelations of rampant corruption at Petroleo Brasileiro SA (“Petrobras”), according to an order issued March 4, 2015 by New York U.S. District Judge Jed S. Rakoff. We were selected as lead counsel by lead plaintiff Universities Superannuation Scheme Ltd. (“USS”).

USS was chosen over three other candidates for lead plaintiff: the SKAGEN-Danske group, made up of three European asset managers; a group of three State Retirement Systems; and an individual investor.

The class action against Petrobras, brought on behalf of all purchasers of common and preferred American Depositary Shares (“ADSs”) on the New York Stock Exchange, as well as purchasers of certain Petrobras debt, principally alleges that Petrobras and its senior executives engaged in a multi-year, multi-billion dollar money-laundering and bribery scheme, which was, of course, concealed from investors. Senior management has openly admitted its culpability. In testimony released by a Brazilian federal court, the executive in charge of Petrobras’ refining division confessed that Petrobras accepted bribes “from companies to whom Petrobras awarded inflated construction contracts” and “then used the money to bribe politicians through intermediaries to guarantee they would vote in line with the ruling party while enriching themselves.” These illegal acts caused the company to overstate assets on its balance sheet, because the overstated amounts paid on inflated third party contracts were carried as assets on the balance sheet.

As of November 2014, the Brazilian Federal Police had arrested at least 24 suspects in connection with Petrobras’ money laundering and bribery schemes; and Brazil’s president, who was a senior Petrobras executive during the relevant period, has also been engulfed in this scandal. As a result of the fraudulent scheme, Petrobras may be forced to book a $30 billion asset writedown in order to reduce the carrying value of some of its assets. That impairment would equal approximately 42% of the company’s market value.

USS was not the lead plaintiff applicant with the largest losses from the fraud. Indeed, the SKAGEN-Danske group, with purported losses exceeding $222 million, asserted by far the largest losses of all the competing lead plaintiff applicants. However, although the securities laws establish a rebuttable presumption in favor of the appointment as lead plaintiff of the movant with the “largest financial interest” in the litigation, that movant must also “otherwise sastisf[y] the requirements of Rule 23 of the Federal Rules of Civil Procedure” under the Private Securities Law Reform Act (“PSLRA”).

In particular, USS and Pomerantz argued that the SKAGENDanske and State Retirement Systems were artificial groupings put together by counsel trying to win the lead counsel position, and were plagued by numerous deficiencies rendering them inadequate to represent the Class. Although the PSLRA states that a lead plaintiff may be a “group of persons,” to allow an aggregation of unrelated plaintiffs (asset managers and pension funds, in this instance) to serve as lead plaintiffs defeats the purpose of preventing lawyer-driven litigation. In stark contrast, USS, the largest pension fund as measured by assets in London, opted to move for appointment as sole lead plaintiff, in order to allow it full and independent control of its counsel and the prosecution of the litigation. In fact, prior to engaging the Pomerantz firm, USS spent over 50 hours of in-house attorney time determining whether to step forward as lead plaintiff. To assist its decision making process, USS retained outside counsel at its own expense to assist it in deciding whether to enter the action.

Moreover, the record in this case demonstrated that the SKAGEN-Danske Group – with SKAGEN showing a net gain on Petrobras common ADSs – had interests that could be deemed antagonistic to purchasers of Petrobras common ADSs. In this case, the large losers in Petrobras preferred ADSs, such as the SKAGEN-Danske Group, potentially have interests antagonistic to common ADS purchasers because of the unique qualities of each security and the potential threats facing the capital structure of Petrobras. USS, with the single largest losses of PBR common ADSs among the various lead plaintiff movants, thus presented the court with an attractive and safe option for potential lead plaintiff.

At bottom, USS argued that it was the ideal plaintiff envisioned by Congress when it enacted the PSLRA. No other movant had demonstrated the willingness and ability to adequately oversee counsel and vigorously prosecute the claims against Petrobras on behalf of the Class. Critically, USS was the only movant not overwhelmed by various inadequacies and unique defenses. Nor did USS have any ties to potentially relevant political contributions or curious arrangements with counsel, which have heretofore afflicted the alternative lead plaintiff groupings.

Accordingly, the independence and diligence evidenced by USS and Pomerantz during the lead plaintiff process ultimately paid off. As articulated during the briefing process, USS’s conduct represented the “gold standard” for institutional oversight of proposed lead counsel, and represents the model for institutional investors seeking to file future applications for appointment as lead plaintiff in securities class actions.

SEC Reverses Its Own Whole Foods Ruling

ATTORNEY: H. Adam Prussin

As we have been reporting for years, corporate America has been at war with activist investors who want the right of “proxy access,” which would allow them to propose nominees for director that can appear on the companies’ own proxy statements. Not too long ago, the SEC backpedaled from a proposed rule that would have granted automatic proxy access to investors who had held a certain percentage of the company’s outstanding shares for an extended period of time. This proposal is now in seemingly eternal limbo.

Instead, investors have sought to put the issue of proxy access to a shareholder vote on a company by company basis. For example, Scott M. Stringer, the New York City comptroller and overseer of five city pension funds with $160 billion in assets, recently put forward proposals at 75 companies that would allow shareholders to nominate directors. In response to these and other similar efforts, some companies have tried to pre-empt those requests by proposing, instead, their own watered-down version of similar proposals – typically with much higher threshold requirements the shareholder would have to meet. An SEC rule states that a shareholder proposal can be excluded if it “directly conflicts with one of the company’s own proposals to be submitted to shareholders at the same meeting.”

Whole Foods is a case in point. A Whole Foods investor proposed that investors holding 3 percent of the grocer’s shares for at least three years be allowed to nominate directors at the company. Whole Foods asked for permission to exclude the proposal last fall, saying that it planned to put its own proposal on director elections to a shareholder vote. Under management’s proposal, an investor interested in nominating directors had to own a far larger stake and to have held it for much longer than in the investor’s proposal.

In its original ruling, issued December 1, the SEC staff granted a no action letter to Whole Foods, allowing it to exclude the shareholder proxy access proposal. Shortly afterwards, 18 other companies asked for no action letters permitting them to do the same. This caused a backlash from institutional investors who viewed this tactic as a too-convenient way for companies to avoid putting more aggressive proxy access proposals to a shareholder vote, and who began asking the SEC to revisit its Whole Foods decision.

On January 16, the SEC announced that it had reversed its Whole Foods decision. In a public statement, SEC Commissioner Mary Jo White said that questions had arisen about “the proper scope and application” of the SEC rule on which its staff had relied when making the decision. She also said she had directed the staff to review the rule and report its findings to the full commission. While its review is underway, the SEC said it would make no rulings on requests for no action letters involving shareholder proposals that are similar to those made by management.

Many view this development as handwriting on the wall, predicting that this preemption tactic is going to be prohibited or at least severely curtailed. Still, without a ruling one way or the other just yet, companies will have to decide for themselves whether to include such proposals in their upcoming proxy statements this spring.


Agencies Shifting Many Enforcement Actions to In-House Administrative Courts

ATTORNEY: Emma Gilmore

The Securities and Exchange Commission and the Commodity Futures Trading Commission have recently signaled that they intend to bring many future enforcement actions in administrative courts rather than federal courts. Kara Brockmeyer, the chief of the Division’s Foreign Corrupt Practices Act Unit, said at a legal conference in Washington held in October that bringing cases as administrative proceedings “is the new normal.”

While both venues have always been available for such actions, the Dodd-Frank Act expanded the powers of administrative courts, allowing them to impose remedies similar to those available in federal court, including the imposition of monetary penalties. The shift has stirred a flurry of public debates on the fairness of the administrative procedures.

Critics argue that the administrative procedure mechanism deprives defendants of constitutional and procedurals advantages, as discovery is limited (essentially precluding depositions, except to preserve evidence); the Federal Rules of Evidence do not apply (even hearsay is admissible); and there is no right to a jury. Those critics also point out that the initial factfinder is an SEC employee, and is therefore presumably biased in the SEC’s favor. They argue that while a defendant can appeal the administrative decision to a federal court of appeals, the court is likely to defer to the administrative agency. Among the fierce critics of such administrative proceedings is Southern District of New York Judge Jed S. Rakoff, who, in a speech last November, argued that “the law in such cases would effectively be made, not by neutral federal courts, but by SEC administrative judges,” saying that administrative proceedings are compromised by “informality” and “arguable unfairness.”

Another federal judge, Lewis A. Kaplan of the Southern District of New York, takes a decidedly different view. He recently held that a defendant’s right to appeal to a federal court at the end of the procedure would suffice to address any injustice or due process violations committed in the administrative proceeding. He concluded that “Congress has provided the SEC with two tracks on which it may litigate certain cases. Which of those paths to choose is a matter of enforcement policy squarely within the SEC’s province,” and the SEC is “especially competent…to determin[e] which…cases are appropriately brought in a district court and which in an administrative proceeding.” (emphasis in original).

In similar vein, the SEC’s Enforcement Division Director Andrew Ceresney defended the agency’s recent shift. “It’s not the case there is no more activity in district court; there is. Having said that, it is certainly the case we’re going to use [administrative] proceedings more often. Why is that? Because Congress gave us the authority under Dodd-Frank to obtain the same remedies in administrative proceedings as we can obtain in district courts,” Ceresney said. He argued at a November 7 conference sponsored by the Practicing Law Institute (“PLI”) that the administrative proceedings process is not only fair to defendants, but also constitutes a more efficient means to reach a resolution. dministrative proceedings are relatively fast, with rulings usually handed down within 300 days of the case being filed, as opposed to years for the typical federal-court case. Ceresney insisted that cases are heard by judges who are seasoned, sophisticated fact finders in the securities field.

At that same PLI conference, CFTC’s Enforcement Division Director Aitan Goelman said a streamlined enforcement proceeding is necessary because his agency is financially constrained and does not have the money to engage in lengthy litigations. The CFTC is mulling a “best-offer” settlement agreement very early in the proceeding in hopes of streamlining the resolution of enforcement disputes.

Another likely reason for the forum shift may be, as the Wall Street Journal recently reported, that the SEC’s win rate in recent years is “considerably higher” in administrative forums than in federal courts. In the 12 months through September 2014, the SEC won all six contested administrative hearings where verdicts were issued, but only 61%—11 out of 18—federal-court trials. Previous years showed the same pattern: the agency won nine of 10 contested administrative proceedings in the 12-month period through September 2013 and seven out of seven in the 12 months through September 2012, according to SEC data. The SEC won 75% and 67%, respectively, of its trials in federal court in those years.

Given the SEC’s success rate in such forum, this shift can prove beneficial to private litigants. Assuming the administrative procedures are fair and do not violate a defendant’s due process rights (and given the administrative law judges’ specialized knowledge of securities laws), appeals courts are likely to affirm the administrative law decisions. SEC-favorable decisions can in turn be employed as highly persuasive authority by private plaintiffs in actions brought against distinct defendants but under analogous fact patterns.


Court Upholds Our Claims Challenging Going Private Transactions

ATTORNEY: Gustavo F. Bruckner

When a controlling shareholder, who also happens to be the CEO of the company, proposes to take the company private, the situation is ripe for abuse. That’s exactly what we believe occurred in the case of Zhongpin Inc., a Delaware company headquartered in China.

In 2013 Xianfu Zhu, Zhongpin’s CEO, who owned 17.3% of the company’s shares, offered to acquire all shares of the company that he did not own for $13.50 per share. Even though there was another, higher offer for the company on the table, Zhu refused to raise his price, stating that he would not remain as CEO if an alternate bidder acquired a majority stake, would not engage in discussions with third-party investors interested in acquiring the company and would withdraw his proposal if the special committee of the Board formed to consider his offer did not approve it within several days.

The special committee retained Barclay’s Bank to act as financial advisor on the transaction, but it later resigned without ever rendering a fairness opinion. Nonetheless, the special committee approved the deal, and a tiny majority of unaffiliated shareholders ratified it.

Pomerantz is co-lead counsel representing shareholders in a class action in Delaware that seeks damages for investors injured by this self-dealing transaction. Defendants moved to dismiss our action, arguing that Zhu was not a controlling shareholder of Zhongpin because he owned only 17.3% of its shares, and that he therefore did not owe fiduciary duties to other shareholders.

Late last year, in a victory for shareholders, Pomerantz successfully argued that even a 17.3% shareholding stake could be sufficient to assert control, and that the transaction therefore had to be evaluated under the “entire fairness” standard. The Chancery Court rejected the motion to dismiss and the case will proceed to trial.

Because they manage the business for the benefit of the shareholders, corporate directors and officers occupy a fiduciary relationship to both the corporation and its shareholders; but shareholders do not normally owe fiduciary duties to other shareholders. However, when a shareholder “controls” the company, courts have found that he or she owes similar duties as directors to the other shareholders. That is because a controlling shareholder can dominate and control the conduct of the Board and will be held to have indirectly acted in a managerial capacity and thus to have assumed the burden of fiduciary responsibility.

The issue of whether Zhu had control was therefore at the heart of defendants’ motion to dismiss. Under Delaware law, clearly a shareholder owning a majority of a corporation’s stock would be considered a controlling shareholder since with one share more than 50%, such a shareholder could place its own designees on the Board and assure every corporate decision is decided in its favor. Courts have found that some large holders, albeit less than majority holders, may still be considered controlling shareholders if they exert actual control over the Board. That is, they have the power to elect their slate of directors, to adopt or reject fundamental transactions proposed by directors or exercise control over the corporation’s business affairs.

The fact that Zhu was CEO and owned a 17.3% stake was not enough to give him control over the board. In fact, Delaware courts had previously dismissed similar claims of control in other cases where the allegedly controlling shareholder held such a small stake.

In our case, the court held that “Plaintiffs do not need to prove that Zhu was a controlling stockholder in order to withstand the motions to dismiss. Rather, Plaintiffs must plead facts raising the inference that Zhu could control Zhongpin.” The court also held that “while most owners of 17% of a corporation’s stock are not controllers, a plaintiff may argue that given the circumstances of a particular case, such a sizeable stockholder actually exercises control.”

Here the court held that the circumstances supported just such an inference. During the sales process, the company filed its annual report which stated that Zhu “has significant influence over our management and affairs and could exercise his influence against” the best interests of shareholders. The annual report referred to him as the “controlling shareholder” and also stated that as a result of his alliances, and pursuant to the company’s By-Laws, he could “exercise significant influence” over the company, including election of directors, selection of senior management, amount of dividend payments, the annual budget, changes in share capital and preventing a change of control. The court concluded that “Zhu exercised significantly more power than would be expected of a CEO and 17% stockholder” and that “one can reasonably conceive that Zhu could ‘control the corporation, if he so wishe[d].”  Under the circumstances, the court held, Zhu’s dominance “left the company with no practical alternatives other than to accept his proposal.”

This has implications for challenges to buy-out proposals submitted by controlling shareholders. Courts seek to protect minority shareholders from the whims and self-interest of controlling shareholders just as they do from the self-interest of corporate directors.

Typically when a shareholder, unhappy over the sale of the company, brings an action against the company’s board of directors to challenge the transaction, a court will defer to the business judgment of the company’s board of directors. The “business judgment rule,” as this protection is known, affords corporate officers and directors who are not subject to self-dealing conflicts of interest immunity from liability to the corporation for losses incurred in corporate transactions within their authority, so long as the transactions are made in good faith and with reasonable skill and prudence. In such a situation, the shareholder-plaintiff has the high burden of proving that the directors’ actions were not made in good faith in order to successfully challenge the transaction.

However, if the directors should have self-interests in the transaction, the burden shifts to the director-defendants to prove the “entire-fairness” of the transaction. The court will also impose the heightened scrutiny of the entire fairness standard of judicial review over the transaction.

Similarly, when a controlling shareholder engages in a self-dealing transaction with its controlled corporation, entire fairness review will apply. That is the standard the court applied here.


Second Circuit Rains on Preet Bhahara’s Insider Trading Parade

ATTORNEY: Jennifer Sobers

Manhattan U.S. Attorney Preet Bharara has dedicated the last five years to cracking down on insider trading, putting dozens of Wall Street traders behind bars. He has had a nearly undefeated record, with over 80 convictions. But then, in December, came U.S. v. Newman, which reversed two convictions directly, led to the dismissal of four guilty pleas, and threatens to make future insider trading convictions far more difficult to obtain.

It seems inconceivable that in 2015 there is still no statute expressly prohibiting insider trading. Instead, courts have analyzed insider trading as a species of securities fraud. 

The Supreme Court has espoused two theories of insider trading – the classical and misappropriation theories. The classical theory applies when a corporate insider trades on, or discloses, confidential company information, in violation of his fiduciary duty to the company and its shareholders. This rule prevents corporate insiders from taking unfair advantage of uninformed shareholders.

The misappropriation theory applies when outsiders, who do not have any fiduciary duty or other relationship to a corporation or its shareholders, gain access to confidential corporate information and trade on it or leak it to others. If, for example, an employee of Company A learns that it intends to acquire company B, and misappropriates that information to trade in shares of Company B, he is culpable even though he owed no duty to shareholders of Company B. That is because he breached his fiduciary duty to his own company, the source of the information, by misusing it for his own purposes.

Courts have expanded insider trading liability to reach situations where the insider or misappropriator in possession of material nonpublic information (“tipper”) discloses the information to another person (“tippee”) who then trades on the basis of the information before it is publicly disclosed. Courts have held that the elements of tipping liability are the same regardless of whether the tipper’s duty arises under the classical or the misappropriation theory. A tipper must have breached a fiduciary duty and must have received an improper benefit in exchange for leaking the information. Tippees, who are often Wall Street brokers, traders, and hedge fund executives, can also be liable for trading on leaked material non-public information if they knew that the leak was a breach of fiduciary duty. Some question remained, however, as to whether they also had to know that the tipper had received an improper benefit.

In Newman, decided in December, the Second Circuit rocked the insider trading legal landscape. The case involves tippees who were several layers removed from the original leak. The three-judge panel held that in order for a tippee in a “classic” insider trading case to be convicted she must have known not only that an insider disclosed the confidential information, but also that she received, in exchange, a significant personal benefit. In finding that evidence lacking here, the Court reversed the convictions of former Level Global Investors L.P. manager Anthony Chiasson and former Diamondback Capital Management, LLC manager Todd Newman, finding that there was no evidence they knew they were trading on information from insiders, or that those insiders received any benefit in exchange for such disclosures. And in a fairly bold step, the Second Circuit instructed the district court on remand to dismiss the Newman and Chiasson indictments with prejudice, as oppose to conducting a new trial.

The case turned on the fact that Newman and Chiasson were three or four levels removed from the corporate insiders who improperly leaked Dell and NVIDIA’s earnings numbers, and claimed that they had no idea that the information came from insiders, much less that those insiders had breached any duty by disclosing the information, or that they had received an improper benefit for disclosing it.

The district court did not instruct the jury that Newman and Chiasson, to be convicted, had to have known about a personal benefit received by the insider. The jury returned a verdict of guilty on all counts. The Second Circuit held that this was error, holding that the tippee had to know that the tipper disclosed confidential information in exchange for personal benefit. In rejecting the government’s position as a “doctrinal novelty,” the court concluded that disclosing confidential information, even if in breach of a fiduciary duty, is not enough, because “although the Government might like the law to be different, nothing in the law requires a symmetry of information in the nation’s securities markets.”

Newman will be a significant obstacle in many future prosecutions, particularly where, as in these cases, the tip was passed along by the original tippee to others both inside and outside the tippee’s organization. These recipients may have no idea who the original source of the information is, much less his motivations for leaking that information.

Compounding this difficulty is the court’s analysis of what does, and does not, constitute a “personal benefit” that triggers insider trading liability. In the past, some courts have been satisfied with de minimus showing of benefits, including such things as “friendship” as a culpable motivation. The Second Circuit obviously now requires more. The personal benefits received in exchange for the Dell tips were such intangible things as: the tipper giving career advice and assistance to the tippee, a fellow business school alumnus, which included discussing the qualifying examination in order to become a financial analyst, and editing the tipper’s resume and sending it to a Wall Street recruiter. The Second Circuit found that the evidence of personal benefit was even more scant in the NVIDIA chain, where the tipper and tippee were merely casual acquaintances who met through church and occasionally socialized together, and the tippee even testified during cross examination that he did not provide anything of value to the tipper in exchange for the information.

The Second Circuit decided that these facts do not evidence a tangible quid pro quo between tipper and tippee. That is, an inference of personal benefit based on the personal relationship between the tipper and tippee is not permissible in the absence of proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature. The government may not prove the receipt of personal benefit by the mere fact of a friendship, or that individuals were alumni of the same school or attended the same church. To hold otherwise, the court reasoned would render the personal benefit requirement a nullity.

Moreover, the Second Circuit found it inconceivable to conclude, beyond a reasonable doubt, that Newman and Chiasson were aware of a personal benefit, when tippees higher up in the tipping chains disavowed any such knowledge. The Court appeared even more skeptical about the liability of the tippees when the tippers themselves had not been criminally charged (and in the case of the Dell tipper, neither administratively nor civilly charged).

This Second Circuit decision may well lead to fewer insider trading prosecutions of remote tippees such as Newman and Chiasson. Already, a number of high-profile district court cases were put on hold awaiting this decision from the Second Circuit. For example, the sentencing of Danny Kuo, a former research analyst at Whittier Trust Co. who pleaded guilty to also trading on illegal tips and sharing information about Dell and NVIDIA, was adjourned on July 1 and rescheduled to within 48 hours of this Second Circuit decision. Kuo was two levels removed from the inside tipper in the NVIDIA chain, which although not as far down the chain as Newman and Chiasson, nevertheless, is remote enough to beg the question of whether Kuo knew the original tipper received a personal benefit from disclosing the insider information. To date, the parties are still considering the effects of the decision on Kuo’s case and have asked the judge for additional time to provide the court with a proposed course of action.

Most recently in January, a federal judge in Manhattan vacated the guilty pleas of four remote tippees charged with trading on inside information involving shares of IBM, and delayed the trial of a fifth man who pleaded not guilty, citing the Second Circuit opinion. Prosecutors in the case argued that because the confidential information came from an outside lawyer, the claim relied on the misappropriation theory of insider trading, to which the Newman decision did not apply. The judge disagreed, finding that the elements of tipping liability are the same, regardless of whether the tipper’s duty arises under the classical or the misappropriation theory. The district judge further stated that the Second Circuit’s unequivocal statement on the point is part of a “meticulous and conscientious effort by the Second Circuit to clarify the state of insider-trading in this Circuit” and as such, the opinion “must be given the utmost consideration.” Bharara, perhaps confident that the district judge would not apply what he called “Newman’s novel holding” to this misappropriation case, conceded in an earlier letter to the judge that if the court found that Newman applies, then the court should dismiss the indictments because the government’s otherwise-sufficient proof would no longer suffice under the Newman definition of a personal benefit. The district judge has yet to decide whether the charges in that case should be dismissed.

The ripple effects of the Second Circuit decision are being felt outside of New York, as defendants in insider trading cases in Boston and California have already tried to take advantage of the ruling. Courts around the country may increasingly have to grapple with Newman, as they often look to the Second Circuit for guidance on insider trading.

Undoubtedly, this turn of events is what led Bharara to recently challenge the Second Circuit ruling. He requested both that the same panel of judges that issued the ruling revisit its decision and, as an alternative, for every judge on the United States Court of Appeals for the Second Circuit to hear the case, a process known as en banc review; and the SEC has also filed a brief supporting a reversal of Newman. In his petition, Bharara contended that the Court’s ruling “threatens the effective enforcement of the securities laws.” Specifically, he argued that the “panel’s erroneous definition of the personal benefit requirement will dramatically limit the government’s ability to prosecute some of the most common culpable and market threatening forms of insider trading.”

Some scholars are of the view that the insider trading landscape may be well-served by concrete laws. Courts very rarely grant en banc review, particularly where the panel’s decision was unanimous. It seems Bharara may welcome the Congressional support in his quest to prosecute inside traders at all levels.

Pom Shorts

ATTORNEY: H. Adam Prussin
Pomerantz Monitor, November/December 2014   

A band of institutional shareholders is mounting the first push ever at 75 United States companies to allow investors to hire and fire directors directly. Leading the drive is Scott M. Stringer, the New York City comptroller, who oversees five municipal public pension funds with $160 billion in assets. He announced that his office will submit a proposal to each of the 75 companies, asking the company to adopt a bylaw allowing shareholders who have owned at least 3% of its stock for three years or more to nominate directors for election to the board. Among those 75 companies are eBay, Exxon Mobil, Monster Beverage and Priceline. State pension plans in California, Connecticut, Illinois and North Carolina are reportedly also supportive of these efforts. 

So far this year, shareholder activists had a success rate of 72 percent in proxy fights, up from 60 percent in 2013, according to FactSet SharkRepellent, a research firm. Notably: 

In our last issue we discussed the proxy battle launched by Starboard to win control over the board of Darden Restaurants, which owns the Olive Garden chain. Both of the top proxy advisory firms, Institutional Shareholder Services and Glass Lewis, recommended that investors vote for all 12 of Starboard’s nominees -- and that’s exactly what they did, ousting the entire incumbent board. Rest assured, Olive Garden will be salting its pasta from here on out. 

So what else is new? It seems like every issue of the Monitor contains news of another multi-billion-dollar settlement of government claims of wrongdoing by our ne’er-do-well banks, and this issue is no exception. This time Citibank, JPMorgan Chase Bank, Royal Bank of Scotland, HSBC Bank and UBS have agreed to pay $4.3 billion to settle claims involving foreign currency transactions. Their currency traders allegedly attempted to manipulate benchmark rates known as the World Markets/Reuters Closing Spot Rates, the most widely referenced benchmark, which is used to establish relative values of different foreign currencies. Often they used information about imminent trades by their own customers to trade ahead of them and reap profits at their expense. The government is reportedly also considering criminal prosecutions against individual traders. 

No sooner were the settlements announced than we heard news that government agencies are investigating various banks, once again including JPMorgan Chase, for trying to collect on loans that have been discharged in bankruptcy. The banks allegedly tried to coerce borrowers to pay those discharged loans by continuing to report the loans to credit reporting agencies as if they were still in default.

Delaware Court Cleans RBC’s Clock

ATTORNEY: Ofer Ganot

The Delaware Chancery Court is extremely unhappy, to say the least, with financial advisors, hired to advise a company on a potential going-private transaction, who have hidden conflicts of interest that taint their advice to the detriment of the company’s public stockholders. We saw this in the In Re Del Monte Foods Company Shareholder Litig. decided by the Delaware Supreme Court in 2011. Now we see it again, in spades, in the In Re Rural Metro Corporation Stockholders Litig

There, Vice Chancellor Laster has come down hard on RBC Capital Markets (“RBC”), which advised Rural Metro that its acquisition by Warburg was fair to its stockholders when, in fact, the offering price undervalued the company by over $91 million. 

Warburg’s acquisition of Rural Metro was announced in March 2011. The total value of the acquisition was approximately $438 million. Two stockholders filed lawsuits challenging the merger, contending that the members of the Rural Metro board breached their fiduciary duties in connection with the merger, and that the company’s financial advisors, RBC (which acted as Rural Metro’s lead financial advisor) and Moelis & Company (which acted as Rural Metro’s secondary financial advisor) aided and abetted the directors in breaching their fiduciary duties. 

The court held two trials – one on the question of liability, decided last March, and the other, decided in October, on apportioning responsibility among the various defendants, including the directors of Rural Metro. At the end of the day, the court held that RBC was almost completely to blame, and accordingly ordered it to pay Rural Metro stock-holders 83% of their total damages, about $76 million. 

What did RBC do wrong? In the court’s view, RBC created a conflict for itself by trying to earn multiple fees, from multiple parties, in the same deal. It offered to provide financing to Warburg to help finance its acquisition of Rural Metro, while at the same time advising the company that the acquisition was fair and should be approved. 

Making matters worse, it also offered to finance an acquisition of Rural Metro’s lone national competitor -- AMR (and its parent company EMS) -- and scheduled the two bidding processes to occur simultaneously. While this was designed to maximize the fees RBC could potentially earn, this was a disastrous strategy for Rural Metro, because bidders could not make offers or even get involved in merger talks and discovery for both companies at the same time, and as a result fewer potential buyers for Rural Metro came forward to bid. The last straw was RBC providing a fundamentally misleading analysis of the fairness of Warburg’s offer, which Rural Metro’s directors then included in the proxy statement seeking stockholder approval. 

The court decided that RBC was 100% responsible for the disclosure violations, which concerned its own financial analyses of Rural Metro’s acquisition. The court also decided that with respect to some of the other breaches of fiduciary duties, RBC had “unclean hands” because it committed “fraud on the board” of Rural Metro, misleading it about its financial analyses, talking it into a disastrous sale strategy, and concealing its conflicts of interest. In such cases, the court held, the advisers may not be entitled to contribution from the other de-fendants. This holding may have the most far-reaching consequences for financial advisors, because it ratchets up their exposure in cases where they mislead the directors.

The court’s analysis resolved several legal issues of first impression under Delaware law, resulting in a 95- page opinion dealing with questions of relative fault, and relative liability, of multiple defendants in a breach of fiduciary duty case. Complicating matters was that other defendants, including the Rural Metro directors, had settled the claims against them prior to trial, triggering complex issues relating to settlements involving some, but not all, “joint tortfeasors.” When such partial settlements happen, the non-settling defendants have the difficult job of proving that it was really the other guys -- those who settled -- who were primarily to blame for what happened and paid less than their fair share in their settlement. In this case, RBC failed at that job and will suffer the consequences.

Investigations As Loss Causations

ATTORNEY: Louis C. Ludwig

The announcement that government agencies have commenced investigations of possible wrongdoing, particularly SEC and FCPA inquiries, has long played an important role in kicking off securities fraud litigation. Recently, however, the universe of these triggering investigations has expanded to include alleged violations of the Lacey Act involving the importation of illegally logged wood from Russia and China; alleged violations of payday lending rules by the U.K.’s Office of Trading; alleged violations of the International Traffic in Arms Regulation; civil investigative demands regarding Medicare fraud; FTC, DOJ, and Senate Finance Committee investigations; and even Chinese governmental investigations of possible corruption. It has been estimated that such cases triggered nearly 10% of securities class action lawsuits filed in 2013. 

This rise in the filing of these “investigation follow-on” actions has drawn increased judicial scrutiny, specifically in regard to loss causation. To state a claim under Section 10(b) of the Exchange Act, a plaintiff must demonstrate, among other things, that the public disclosure of a misrepresentation caused plaintiff’s complained-of financial loss (or “loss causation”). To satisfy this requirement, there usually has to be a “corrective disclosure” of the true facts which, in turn, causes the losses. The question, then, is whether the announcement that an investigation has begun amounts to a “corrective disclosure.” 

In August, the Ninth Circuit issued Loos v. Immersion Corp., which holds that the “announcement of an investigation, standing alone, does not give rise to a viable loss causation allegation[,]” even though the announcement was accompanied by a drop in share price. To reach this outcome, the Ninth Circuit reasoned that the announcement of investigation disclosed only the “risk” or “potential” for widespread fraudulent conduct, and did not “reveal” fraudulent practices to the market. As stated in Meyer v. Greene, a 2013 Eleventh Circuit opinion followed by the Immersion court, “the announcement of an investigation reveals just that-an investigation-and nothing more.” 

In September, the Ninth Circuit amended its opinion in Immersion to clarify that the court did “not mean to suggest that the announcement of an investigation can never form the basis of a viable loss causation theory.” The court added that “[t]o the extent an announcement contains an express disclosure of actual wrongdoing, the announce-ment alone might suffice” to support loss causation by itself. But what happens if the fraud hinted at by an investigation isn’t confirmed for months, or even years? 

The optimistic take is that if an investigation ultimately bears fruit, loss causation may be shown in hindsight. Interestingly, the Immersion plaintiff argued this exact point, claiming vindication by way of post-class period disclosures that Immersion’s financial statements were unreliable and would have to be restated. Unfortunately, the Ninth Circuit deemed that argument waived because plaintiff failed to raise it before the district court or in his complaint, so it’s uncertain how it would play out on the merits. We do know that the amended Immersion opinion states that its holding doesn’t affect investigatory announcements bolstered by a “subsequent disclosure of actual wrongdoing[,]” implying that such fact patterns are actionable. This appears to validate the Immersion plaintiff’s claim that later revelations “‘solidif[ied] the causative link’ between the fraud and his loss.” He simply failed to plead that link in time. 

If this reading is correct, it raises an additional question: with a two-year statute of limitations governing Exchange Act claims, and with investigations notoriously slow to resolve, should a potential 10(b) plaintiff faced with an investigatory announcement, but no definitive “corrective disclosure” or admission of wrongdoing, file anyway? On one hand, the claim would be preserved – a plaintiff could “wait-and-see,” then, provided that the fraud was ultimately confirmed, argue that the investigation heralded a later “materialization of the risk.” On the other hand, the court could run out of patience prior to the needed corrective disclosure and dismiss the complaint. The difficulty here is that statutes of limitations typically do not start to run until the cause of action “accrues,” which means that enough facts are disclosed to allow investors to file a claim. If there is uncertainty as to whether disclosure of an investigation is sufficient to support a claim, a plaintiff who does not file a case right away risks falling afoul of the statute of l imitations, resulting in the claim being time-barred. 

Practically, the best advice for plaintiffs is to take Immersion at its word and avoid pleading an announcement of investigation as a stand-alone basis for loss causation. Multiple disclosures are often simply unavailable, but as Immersion shows, they should be ferreted out in the pre-filing in-vestigation and pleaded whenever possible. This is demonstrated by Public Employees Retirement System of Mississippi et al. v. Amedisys, Inc., issued by the Fifth Circuit in October as the first decision to grapple with Immersion. In contrast to Immersion, the Fifth Circuit upheld the complaint in Amedisys, which alleged, as corrective disclosures, the announcement of investigations by the DOJ, SEC, and Senate Finance Committee, along with the following additional disclosures: a report published by Citron Research raising questions about Amedisys’s billing; executive resignations; and a number-crunching WSJ article con-cluding that Amedisys was “taking advantage of the Medicare reimbursement system.” While opining that some of these allegations, standing alone, would be insufficient to show loss causation, the court held that the multi-ple partial disclosures “collectively constitute and culminate in a corrective disclosure that adequately pleads loss causation...” In sum, Immersion and Amedisys teach that there is strength in numbers. 

As a postscript, a Pomerantz case, In re LifeLock Sec. Litig. (D. Ariz.), will be the first test of Immersion at the district court level nationwide. Plaintiff alleges that LifeLock de-liberately turned off “identity theft prevention” alerts to elderly customers in violation of a 2010 settlement with the FTC that required ongoing compliance (and honesty with consumers). After a whistleblower came forward, the FTC re-opened its inquiry into LifeLock, causing shares to drop. In their pending motion to dismiss, defendants argue for a broad reading of Immersion, in which investigatory announcements are presumptively ill-suited to support an allegation of loss causation. Plaintiff contends that the renewed investigation didn’t merely portend a “risk” of fraud, but was instead a materialization of LifeLock’s noncompliance with the FTC settlement. Most importantly, the complaint also pleads additional disclosures, making the upcoming ruling not only a test of Immersion, but of the countervailing approach on display in Amedisys as well.

Pomerantz Achieves Additional Victories for BP Investors

ATTORNEY: H. Adam Prussin

BP p.l.c. is a U.K. corporation with substantial U.S. operations. Its common stock trades on the London Stock Exchange (LSE), while its American Depository Shares (ADS) trade on the New York Stock Exchange (NYSE). In April 2010, the Deepwater Horizon offshore drilling rig chartered to BP exploded and sank, killing 11 people and spilling roughly five million barrels of crude oil into the Gulf of Mexico before the blown well was capped. 

Since 2012, Pomerantz has been pursuing ground-breaking claims on behalf of nearly three dozen institutional investors to recover losses in both BP securities stemming from allegedly fraudulent pre-spill statements about BP’s safety reforms and post-spill statements about the scope of the spill. 

The challenge has been to craft a legal strategy that would permit our clients to pursue claims for their LSE-traded BP shares in U.S. courts, notwithstanding the U.S. Supreme Court’s 2010 decision in Morrison v. Nat’l Australia Bank Ltd., which foreclosed use of the U.S. federal securities laws to pursue claims over foreign-traded securities. Throughout the litigation, BP has sought to get the cases dismissed, for litigation in foreign courts with disadvantageous rules, relying on Morrison and a litany of factual and legal arguments. As the Monitor reported last year, Pomerantz already defeated BP’s motion to dismiss claims brought by our first tranche of clients, three U.S. public pension funds. 

This time, in a series of landmark rulings by U.S. District Judge Keith P. Ellison of the Southern District of Texas in October 2014, Pomerantz defeated BP’s motion to dismiss claims brought by our second tranche of clients. Specifically, the court rejected BP’s attempts to: (i) dismiss foreign investors’ lawsuits so as to require them to be litigated abroad; (ii) extend the reach of a U.S. federal law so as to require dismissal of both foreign and domestic investors’ English common law claims, and (iii) shorten the time periods within which a U.S. federal securities claim (for our clients’ ADS losses) could be filed. Each of these cutting-edge victories preserved claims for our clients. 

Pomerantz Secures Rights of Foreign Investors to Sue in U.S. Courts

In the most significant October 2014 ruling, Pomerantz has now established the right of foreign investors who  purchased foreign-traded shares of a foreign corporation to pursue foreign-law claims for securities fraud losses in a U.S. court. This hard-fought outcome represents the first time after the Supreme Court’s Morrison decision that such claims have been permitted to proceed in a U.S. court. 

A year ago, Pomerantz defeated BP’s motion to dismiss similar claims by U.S.-based pension funds, when Judge Ellison held that their claims had sufficient ties to the U.S. to warrant adjudication here – rather than in England – even after he decided to apply English common law. At that time, facing only U.S. plaintiffs, he also did not credit BP’s arguments that Morrison or the U.S. Constitution prohibited such an outcome as impermissible regulation of foreign commerce. 

This time, BP, once again invoking the Morrison holding, sought to dismiss the cases of Pomerantz’s foreign clients under the same forum non conveniens doctrine, so that they would have to litigate their cases in English courts. Given the English system’s restrictions on contingent fee litigation and its imposition of a “loser pays” approach on legal fees, this argument posed a serious threat to the viability of our clients’ cases. BP’s argument, boiled down, was that because these clients were “foreign,” their cases necessarily had a stronger nexus to England – even though many of our “foreign” clients hailed from nations outside the U.K. (and indeed outside of Europe). 

After extensive briefing, Pomerantz Partner Matthew Tuccillo argued against dismissal in a multi-hour hearing in July 2014. He successfully argued that Pomerantz’s foreign clients deserved the same deference on their choice of forum as our U.S. clients. Drawing upon extensive advance due diligence that he and Pomerantz Associate Jessica Dell had conducted with the outside investment management firms that serviced our clients, Mr. Tuccillo then persuaded Judge Ellison that our foreign plaintiffs’ cases had considerable ties to the U.S., such that BP had not met its burden to disrupt their forum choice.

Pomerantz Defeats BP’s Attempt To Extend SLUSA Dismissal to Foreign Law Claims 

BP also argued that the Securities Litigation Uniform Standards Act (or “SLUSA”), which in certain instances requires dismissal of securities claims brought under U.S. state law, should be extended to apply to foreign-law claims. Under BP’s interpretation, SLUSA would have mandated dismissal of the English common law claims of all of Pomerantz’s foreign clients and U.S. non-public clients. 

Here, Pomerantz forcefully argued that the Exchange Act of 1934 expressly defined the “State” law claims to which SLUSA applies as those brought under the laws of “any State of the United States, the District of Columbia, Puerto Rico, the Virgin Islands, or any other possession of the United States.” As Mr. Tuccillo argued to Judge Ellison in July, “Defendants ask this Court to do nothing less than to rewrite, selectively, an unambiguous statute that was duly elected by Congress to suit their purposes, and the Court should decline to do so.” Judge Ellison agreed. 

Judge Ellison also rejected BP’s argument that the original pleading of Texas law claims (later amended to be English law claims) and/or the use of Texas choice of law rules to identify English law as the governing substantive law served to trigger SLUSA’s dismissal provisions. In doing so, he validated our read of the existing split in the national case law on SLUSA’s application. 

These rulings were significant, as they preserved the lawsuits of dozens of BP plaintiffs, including both foreign and domestic institutions represented by Pomerantz and other firms. 

Pomerantz Establishes a Broader Time Period for Exchange Act Claims

The court also ruled in Pomerantz’s favor as regards the U.S. federal securities claims being pursued by some of our foreign and domestic clients who purchased BP’s ADS on the NYSE. Normally, the pendency of a class action will serve to toll the applicable statute of limitations for individual plaintiffs who may later pursue the same claim. Here, a parallel class action has sought to pursue, on a class-wide basis, a claim under Section 10(b) of the Exchange Act for losses in BP’s NYSE-traded ADS (although, notably, the court has more recently failed to certify most of the proposed class). 

BP had argued that Pomerantz’s clients waived this tolling by filing their individual lawsuits prior to the adverse decision on class certification in the class action. BP also argued that in any event, the statute of repose for our clients’ Exchange Act Claims, which is normally intended to be the “outside” date by which a claim must be filed, was never tolled. These arguments, if credited, would have served to bar as untimely our clients’ Exchange Act claims. 

Judge Ellison sided with us on both arguments, thereby preserving tolling of both the statute of limitations and the statute of repose. The repose ruling in particular was significant, because there is a deep divide in the case law nationally, and the Supreme Court had been poised to hear the issue this term (before the case raising it was settled). These rulings permit our clients to continue to file Exchange Act claims regarding their BP ADS losses, a very valuable right in the wake of Judge Ellison’s decisions denying class certification for most of the time period at issue in the parallel class action.

The Path Ahead

Together, these landmark rulings have highlighted a new path toward recovery in U.S. courts for foreign investors pursuing foreign law claims regarding their losses in foreign-traded securities. Ever since Morrison was decided in 2010, no other case like this has survived. 

Pomerantz serves on a court-appointed Steering Committee overseeing all individual actions against BP by institutional investors and serves as the sole liaison with the court and BP. Our third tranche of plaintiffs’ cases is already on file, and discovery is anticipated to commence in all cases in the near future. 

Pomerantz currently represents nearly three dozen institutional plaintiffs in the BP litigation, including U.S. public and private pension funds, U.S. limited partner-ships and ERISA trusts, and pension funds from Canada, the U.K., France, the Netherlands, and Australia. The BP litigation is overseen by Partners Marc Gross, Jeremy Lieberman, and Matthew Tuccillo. 

To Salt or Not to Salt, That Is the Question


Starboard Value LP, a hedge fund, is trying to take over Darden Restaurants, the parent company of Olive Garden restaurants. Recently it made history, of a sort, when it sent out a 300 page proxy statement asking shareholders to vote for its 12 nominees to the Darden board. Its solicitation was a soup to nuts critique of everything it believes is wrong with Olive Garden and its recipe for fixing it all. What makes it noteworthy is its scathing attack on the restaurants themselves. Most notable: it expresses outrage that Olive Garden does not add salt to the water it uses for cooking its pasta, a practice it believes to be universal everywhere else. Starboard characterized this non-salting as an “appalling decision [that] shows just how little regard management has for delivering a quality experience to guests.” This generated a lot of buzz from casual observers who could care less about Starboard’s takeover efforts. Most people apparently agree that failing to salt the water is a serious faux pas.

Not content with pouring salt on this open wound, Starboard also criticized Olive Garden for oversupplying guests with unlimited breadsticks and salad. While not saying much about the salting issue, Darden did vigorous¬ly debate the issue of the endless breadsticks. Starboard had contended that Olive Garden was wasting millions of dollars by delivering more breadsticks to each table than customers normally eat, though it has said it doesn’t want to get rid of unlimited breadsticks. Darden’s rejoinder: its breadstick generosity “an icon of brand equity since 1982″ and claims that it “conveys Italian generosity.” 

Institutional Shareholder Services and Glass Lewis, the two leading proxy advisory firms, have both rec-ommended that their institutional clients vote in favor of all 12 Starboard nominees. The vote is next month. 

We’ve been to Olive Garden. Salt and breadsticks are the least of their problems.

Is Da Fix In?


About two years ago, the Commodities Futures Trading Commission started an investigation into whether the world’s largest banks had conspired to manipulate ISDA¬fix, a benchmark similar to LIBOR, which in this case is used to set rates for trillions of dollars of complex financial products, such as interest-rate swaps. Much of the evidence collected by the CFTC seems to have been provided as a byproduct of the LIBOR rate-fixing investigation. Pomerantz currently represents a number of banks and financial institutions in a class action on behalf of lenders arising out of the LIBOR rate-rigging scandal.

A few weeks ago, the press reported that the CFTC reported to the Justice Department that it had found evidence of criminal collusion in manipulating ISDAfix rates. 

Here we go again. 

Until this year, the dollar-denominated version of the ISDAfix rate was set daily by ICAP, a brokerage firm, based on price quote data submitted by banks. Once the CFTC started investigating, ICAP lost that central role.

Bloomberg News reported last year that the CFTC had found evidence that traders at Wall Street banks had instructed brokers to buy or sell as many interest-rate swaps as necessary to rig ISDAfix, by moving it to a predetermined level. Doing so helped banks reap millions of dollars in trading profits, at the expense of companies and pension funds.

Since then, the Alaska Electrical Pension Fund has filed a civil action accusing 13 banks, including Barclays, Bank of America and Citigroup, of conspiring to fix ISDAfix. The Fund claimed the banks did this in order to manipulate payments to investors on the derivatives. The banks’ alleged actions affected trillions