This quarter’s issue includes summaries and associated court opinions of selected cases principally decided between May and August 2019.
In a 139-page post-trial opinion, Vice Chancellor J. Travis Laster awarded petitioners seeking appraisal of shares of Stillwater Mining Company the merger price of $18 per share, plus interest. The appraisal litigation arose from Sibanye Gold Limited’s acquisition of Stillwater in 2017. In determining that the deal price of $18 per share was the best indicator of fair value, the Court of Chancery looked to recent decisions, including the Delaware Supreme Court’s ruling in Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd., 177 A.3d 1 (Del. 2017), and found that “objective indicia” present in the sale process “provide[d] a cogent foundation for relying on the deal price as a persuasive indicator of fair value,” at least as an initial matter. Specifically, the court observed that: (1) “the Merger was an arm’s-length transaction with a third party,” not a controlling stockholder; (2) “the Board did not labor under any conflicts of interest,” as “[s]ix of the Board’s seven members were disinterested, outside directors”; (3) “Sibanye conducted due diligence and received confidential information about Stillwater’s value”; (4) “Stillwater negotiated with Sibanye and extracted multiple price increases”; and (5) “[m]ost importantly, no bidders emerged during the post-signing phase.”
The court similarly rejected the plaintiffs’ contention that the company’s CEO statement on a November 2016 earnings call that the company “thinks” they “adequately” addressed the issues the FDA raised was materially misleading and concealed material risks to the company’s business. The court determined that the CEO’s statement was an opinion and the plaintiffs failed to adequately allege that the CEO omitted material facts that would lead an investor to doubt its reliability. The court likewise rejected the plaintiffs’ argument that the company’s statements on a May 2017 earnings call that the company “expected” to be able to timely resolve issues identified by the FDA were actionable because they were forward-looking statements “accompanied by appropriate cautionary language.” Finally, the court agreed with the defendants that the plaintiffs failed to plead a strong inference of scienter because the plaintiffs “ignore the disclosures about the Forms 483 ... which undermine an inference of an intent to deceive.”
SEC Enforcement Actions
Tenth Circuit Affirms That Investment Adviser Had Duty To Correct Firm’s False Statements
In the first case by a Court of Appeals to apply the U.S. Supreme Court’s recent decision in Lorenzo v. SEC, 139 S. Ct. 1094 (2019), the Tenth Circuit affirmed the decision of an SEC administrative law judge that an adviser who worked for an investment advisory firm violated Section 10(b) of the Securities Exchange Act and Rule 10b-5 promulgated thereunder by failing to correct the firm’s material misstatements. The SEC found that the adviser — who had an arrangement where he received a portion of the commissions collected by a certain brokerage firm (where he previously worked) and directed trades on behalf of his advisory clients through that brokerage firm — had a duty to correct the advisory firm’s disclosures that its advisers (including the defendant) had no conflicts of interest. The SEC determined that the failure to correct the advisory firm’s “false or misleading statements ... trigger[ed] liability for employment of a fraudulent or deceptive scheme” under Rules 10b-5(a) and (c).
On appeal, the adviser argued that correcting material misstatements is under the ambit of Rule 10b-5(b) (which prohibits making false and misleading statements in connection with securities transactions) and not Rules 10b-5(a) or (c) (which prohibit fraudulent schemes and practices), and that the SEC “obliterated the distinction between the two categories of prohibited conduct.” Applying Lorenzo — which held that someone who is not a “maker” of a misstatement under Rule 10b-5(b) may still violate Rules 10b-5(a) and (c) by knowingly distributing those misstatements — the court rejected the adviser’s argument. The court found that the adviser’s awareness “that a conflict existed,” his knowledge that his firm “was telling its clients that he was independent,” along with his failure to correct the firm’s statements or to disclose his conflict,” constituted an illegal scheme.
Securities Exchange Act
SDNY Dismisses Excessive Fee Allegations Against Investment Advisory Firm
In re Davis N.Y. Venture Fund Fee Litig., No. 14 CV 4318-LTS-HBP (S.D.N.Y. July 3, 2019)Click here to view the opinion.
Judge Laura Taylor Swain dismissed on summary judgment an excessive fee claim brought under Section 36(b) of the Investment Company Act against a mutual fund adviser. Section 36(b) imposes a fiduciary duty on investment advisers regarding their compensation for servicing mutual funds. Under Section 36(b), an adviser is prohibited from charging a fee so disproportionately large to the services provided to those funds that it could not have been the result of arm’s length bargaining. Gartenberg v. Merrill Lynch Asset Mgmt., Inc., 694 F.2d 923 (2d Cir. 1982). When assessing excessive fee allegations, courts analyze the factors set forth in Gartenberg and endorsed by the U.S. Supreme Court in Jones v. Harris Associates L.P., 559 U.S. 335 (2010), including (1) “the independence, expertise, care, and conscientiousness of the board in evaluating adviser compensation”; (2) “comparative fee structure”; (3) “the nature and quality of services provided to the fund and shareholders”; and (4) “the profitability of the fund to the adviser.”
The court dismissed the plaintiffs’ excessive fee claim under the Gartenberg framework. The court first rejected the plaintiffs’ argument that the procedures employed by the investment fund’s board in approving the agreement were insufficient to warrant deference. The court determined, for example, that the board conscientiously reviewed substantial materials on the differences in scope, scale and risk of advisory versus subadvisory services. Consequently, the court held that “the Board’s review process was sufficiently robust to warrant a significant degree of deference to the Board’s decision to approve [the defendant’s] advisory fee.”
The court also rejected the plaintiffs’ comparison of advisory and subadvisory fees, which were charged “dramatically lower fees,” as inapt. The adviser’s comparisons to its fees charged to peer and other retail funds were more apt. “Even if the Subadvised funds could be found to be probative as to the lower end” of the appropriate range, the funds proffered by the defendant “provide[d] an uncontroverted apt comparison, establishing that the range of arm’s length fees encompasse[d] those paid by the” fund at issue.
The court next rejected the plaintiffs’ argument that the performance of the fund demonstrated that the fees were excessive. Although the plaintiffs “proffered sufficient facts to enable a rational factfinder to conclude that [the fund’s] performance was below standard to at least some degree,” the plaintiffs failed to proffer “evidence that the Fund’s deviation from its benchmark ... was particularly dramatic or unusual.” Finally, with regard to profitability, the court concluded that the plaintiffs failed to proffer “evidence to demonstrate that, when viewed holistically in the context of the other Gartenberg factors, [the adviser’s] profits [of 73-81%] were out of proportion to the services rendered.”
SDNY Denies Motion To Dismiss Market Manipulation Claim Against Stock Exchanges
In re Barclays Liquidity Cross and High Frequency Trading Litig., No. 14-MD-2589 (JMF) (S.D.N.Y. May 28, 2019) Click here to view the opinion.
Judge Jesse M. Furman denied a motion to dismiss a claim brought by a putative class of shareholders against seven securities exchanges alleging that they violated Section 10(b) of the Securities Exchange Act by providing services to high-frequency trading firms in a way that manipulated the market. The plaintiffs originally brought claims under Sections 10(b) and 6(b) of the Securities Exchange Act against the exchanges and certain high-frequency trading firms. The district court dismissed all of the claims because the conduct did not rise to being unlawfully “manipulative” and the exchanges had immunity as quasi-governmental agencies. The plaintiffs appealed. The Second Circuit vacated the dismissal and held that the plaintiffs sufficiently alleged that the defendants’ conduct was manipulative under Section 10(b) and that the exchanges were not immune.
The exchanges again moved to dismiss, arguing that the plaintiffs lacked Article III standing to bring the lawsuit and failed to adequately plead the statutory elements of a Section 10(b) market manipulation claim. The court held that while it was a close call, the plaintiffs adequately alleged an injury in fact to have Article III standing. The plaintiffs sufficiently alleged that the exchanges distorted stock prices through the services they provided to the high-frequency traders and that these distortions were so pervasive and routine that any trader, including the plaintiffs, would be exposed to the distorted prices. The court rejected the exchanges’ argument that the plaintiffs may have benefited from the allegedly distorted stock prices, reasoning that the pleading stage was not the time to determine if the plaintiffs’ injury may have been outweighed by potential benefits.
The court then held that the plaintiffs sufficiently pleaded the substantive elements of a Section 10(b) market manipulation claim: standing, reliance, loss causation, scienter and particularity. The plaintiffs sufficiently alleged the statutory “standing” element because they were purchasers or sellers of securities. The plaintiffs sufficiently alleged reliance on the defendants’ deceptive acts under the presumption that a plaintiff who was injured by “a defendant’s failure to disclose material facts reasonably relied on the absence of those facts” (the Affiliated Ute presumption). The court determined that use of this presumption at the pleading stage was appropriate where proving reliance on a negative would be nearly impossible. The court further held that the plaintiffs sufficiently alleged loss causation and plausibly alleged that the exchanges’ offering products to certain traders was a proximate cause of the alleged economic loss suffered. The court finally held that the plaintiffs sufficiently alleged scienter because their allegations raised a “cogent and compelling” inference that the defendants acted with scienter by understanding how the services they offered could be exploitative.
Securities Fraud Pleading Standards
Court Dismisses Putative Securities Class Action Arising Out of Deadly Fire in London
Howard v. Arconic Inc., No. 2:17-cv-1057 (W.D. Pa. June 21, 2019) Click here to view the opinion.
Judge Mark R. Hornak dismissed a putative securities class action against Arconic, Inc., a manufacturer of aluminum cladding, and certain of its officers and directors, for alleged violations of Section 11 of the Securities Act and Section 10(b) of the Securities Exchange Act.
One of Arconic’s products, an aluminum paneling system, formed the exterior part of the Grenfell Tower in London that was destroyed in a 2017 fire that resulted in 72 deaths and more than 70 injuries. In the wake of the tragedy, some new outlets reported that Arconic’s panels contributed to the fire’s rapid spread and that the panels should not have been used on buildings that tall. The plaintiffs filed suit, claiming that Arconic’s statements in SEC filings, brochures and presentations to investors violated securities laws by failing to disclose the alleged sale of Arconic’s products for unsafe uses. The plaintiffs further alleged that a U.K.-based sales employee for one of Arconic’s foreign subsidiaries had reason to know that Arconic’s product would be improperly used in the tower that caught fire.
The court dismissed both the Section 11 and Section 10(b) claims, explaining that three related and fundamental flaws pervaded both of the plaintiffs’ claims. First, the plaintiffs failed to adequately plead that the paneling system that was used in the Grenfell Tower had been sold for inappropriate end uses other than on that one tower. Given that pleading failure, the plaintiffs could not sustain a claim based on an alleged failure to disclose sales for inappropriate end uses. Second, the plaintiffs failed to adequately plead that any Arconic executive knew that its paneling system was being sold for improper purposes. Thus, the plaintiffs did not plead the required mental state for purposes of their Securities Exchange Act claim. Third, while the plaintiffs repeatedly pointed to Arconic’s alleged failure to inform investors that the aluminum paneling had been sold for use on the Grenfell Tower, the allegations in the complaint did not plausibly show that a failure to inform investors of a single sale to an end user who would use the product unsafely provided a basis for a securities — as opposed to a products liability — claim.
New Jersey District Court Dismisses Putative Class Action Against Pharmaceutical Company That Failed To Disclose Trial Investigator’s Conflicts in Breast Cancer Study
Biondolillo v. Roche Holding AG, No. CV 17-4056 (D.N.J. June 17, 2019) Click here to view the opinion.
The court granted dismissal in a putative class action against pharmaceutical company Roche Holding AG and four of its executives arising out of an alleged failure to disclose purported conflicts on the part of the trial investigator in the company’s breast cancer study.
Roche sponsored a phase III study to test the effects of various treatment options on post-surgery breast cancer patients. While the full study results would not be revealed until a June 2017 conference, on March 2, 2017, Roche issued a press release announcing “positive results” in the trial and claiming that the study found a “statistically significant improvement in invasive disease-free survival” and “met its primary endpoint.” When the full results were revealed in June 2017, however, “the consensus by [o]ncologists [was] that the study was a disappointment.” Fifteen months later, in September 2018, The New York Times published an article revealing that the trial investigator had received over $3 million in payments from Roche for consulting fees and for his stake in a company that Roche acquired.
In the wake of The New York Times article, the plaintiffs filed suit, claiming that the March 2, 2017, press release was materially misleading because it failed to disclose the trial investigator’s conflict of interest. In ruling on the defendants’ motion to dismiss, the court explained that “[t]his case raises the interesting question of whether publishing the results of a study without disclosing conflicts of interests is a misrepresentation.” However, the court did not need to answer that question because the plaintiffs failed to plead (1) that the alleged misrepresentation was material (even if it was misleading); or (2) loss causation. The court reasoned that to demonstrate materiality and loss causation, the plaintiffs needed to show that Roche’s stock price fell when the trial investigator’s conflict was revealed to the public. Here, however, Roche’s stock price fell in June 2017, when the disappointing trial results were revealed, not in September 2018, when the trial investigator’s conflicts were revealed.
Eastern District of Pennsylvania Declines to Dismiss Securities Suit Against Generic Drug Company Based on Alleged Misstatements Regarding Anti-Competitive Conduct in Industry
Utesch v. Lannett Co., Inc., No. CV 16-5932 (E.D. Pa. May 15, 2019) Click here to view the opinion.
Judge Wendy Beetlestone denied a motion to dismiss a putative federal securities class action against Lannett Company and two of its officers, alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act.
Lannett is a pharmaceutical company that derives most of its revenue from the sale of generic drugs. Starting in 2014, multiple state and federal agencies began investigating various generic drug manufacturers, including Lannett, with regard to alleged anti-competitive and/or criminal conduct relating to price-fixing in the industry. In SEC filings, Lannett downplayed the investigations, consistently maintaining that “the generic pharmaceutical industry is highly competitive” and that “we face strong competition in our generic competition business.” The plaintiffs alleges that such statements were false or misleading. The plaintiffs further alleged that as information about potential wrongdoing in the generic drug industry and about the investigations into that wrongdoing became public, Lannett share prices fell.
In denying the defendants’ motion to dismiss, the court held that the plaintiffs had adequately pleaded falsity, scienter and loss causation. With respect to falsity, the court held that the plaintiffs sufficiently alleged the “who, what, when, where and how” of the alleged misrepresentations. Most plainly, while the defendants maintained that “we face strong competition in our generic produce business,” the complaint alleged just the opposite — that the market for the defendants’ generic products was riddled with anti-competitive conduct. With respect to scienter, the court explained that the “most powerful evidence of scienter is the content and context” of the misleading statements. Here, the defendants’ statements that the market was “highly competitive” and that they faced “strong competition” were made without equivocation, even though there was (1) an ongoing set of investigations into the industry, (2) significant public evidence that price patterns were not following ordinary trends, and (3) ongoing questions in the press about collusive conduct. The defendants’ statements denying any anti-competitive conduct — which statements were made with “certitude” — suggested that they were made with the requisite scienter. The court also held that the statements related to “core matters of central importance” to Lannett, which further supported a finding of scienter. Finally, with respect to loss causation, the court held that the plaintiffs had plausibly alleged that Lannett’s stock price dropped immediately after the disclosure of information related to the investigation into the pricing of Lannett’s drugs.
Ninth Circuit Reverses Dismissal in Action Against Trustee, Holds State Law Claims Are Not Precluded by SLUSA
Banks v. N. Trust Corp., No. 17-56025, 929 F.3d 1046 (9th Cir. July 5, 2019) Click here to view the opinion.
The Ninth Circuit reversed the dismissal of a putative class action brought against Northern Trust Company for violations of state law involving breaches of fiduciary duty by a trustee, holding that the Securities Litigation Uniform Standards Act (SLUSA) did not bar the plaintiff’s claims.
The plaintiff is the beneficiary of an irrevocable trust. The defendant trustee has sole discretion in how to manage the trust’s assets. The plaintiff alleged that the defendant breached its fiduciary duty by investing the trust’s assets in its own affiliated funds rather than seeking superior investment opportunities outside of the defendant’s own funds.
The district court dismissed the claims with prejudice, holding that because the allegedly imprudent investments were in connection with the purchase or sale of covered securities and featured material misrepresentations or omissions, SLUSA precluding the plaintiff from bringing those state law fiduciary duty claims as a class action in federal court.
The Ninth Circuit reversed. The court explained that SLUSA deprives a federal court of jurisdiction to hear (1) a covered class action (2) based on state law claims (3) alleging that the defendants made a misrepresentation or omission or employed any manipulative or deceptive device (4) in connection with the purchase or sale of (5) a covered security. Here, the case turned on the “in connection with” requirement — whether the defendant trustee’s alleged activity was “in connection with” the purchase or sale of a covered security. The court noted that, based on U.S. Supreme Court precedent, the “in connection with” requirement should be interpreted broadly, and “it is enough that the fraud alleged ‘coincide’ with a securities transaction.”
However, notwithstanding that the requirement should be interpreted broadly, a misrepresentation or omission is not “in connection with” the purchase or sale of a covered security unless the alleged fraudulent conduct is material to a decision by someone “other than the fraudster” to buy or sell the covered security. Here, the plaintiff did not make any investment decisions based on the defendant’s conduct or statements. Rather, the plaintiff alleged that she had not control over how the defendant invested the trust’s assets because the plaintiff was only the beneficiary of an irrevocable trust. Thus, “because the trustee can deceive only itself with any alleged misconduct, its misconduct does not require SLUSA preclusion.”
Northern District of Illinois Grants Motion To Dismiss State Law Class Action Claims Precluded by SLUSA
Gray v. TD Ameritrade, Inc., No. 18 C 00419 (N.D. Ill. May 13, 2019) Click here to view the opinion.
Judge Charles P. Kocoras granted a motion to dismiss state law class action claims barred by SLUSA. The plaintiffs were customers of TD Ameritrade, which provided them with an online trading platform for investment and operated a program through which it introduced its customers to investment advisers. Through this program, TD Ameritrade introduced the plaintiffs to advisor Sheaff Brock, which represented to the plaintiffs that its investment strategy — the put options income strategy — was conservative. The plaintiffs alleged that, in reality, the strategy was “aggressive and speculative” and resulted in the plaintiffs suffering “staggering losses.” The plaintiffs filed a complaint on behalf of themselves and the putative classes they represented for breach of contract, breach of fiduciary duty, money had and received, and a violation of the Illinois Consumer Fraud and Deceptive Business Practices Act. The defendants TD Ameritrade and Sheaff Brock filed a motion to dismiss the complaint pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure, arguing that the action was precluded by SLUSA.
The plaintiffs argued that SLUSA does not apply because the “in connection with” requirement could not be met where they gave the defendants complete discretion over investment decisions. The court disagreed and emphasized that “a plaintiff need not personally make the investment decision to satisfy the ‘in connection with’ requirement; rather, the fraud has to coincide with the covered securities transaction.” Here, Sheaff Brock’s alleged misrepresentations about its conservative investment strategy and expected returns coincided with the covered securities transactions because they were foundational to the claim. Moreover, those representations were the reason the plaintiffs hired Sheaff Brock to engage in securities transactions on their behalf.
Additionally, the court rejected the plaintiffs’ argument that the complaint does not involve a “covered security” because it alleged misrepresentations about the defendants’ investment strategy, not underlying stocks or options that caused the plaintiffs’ losses. The court found that any misrepresentation regarding the success or failure of a trading strategy necessarily involves the underlying securities. Thus, where the underlying securities are traded on national exchanges and regulated by the SEC, and the defendants agreed to be subject to the rules of the Options Clearing Corporation, they are “covered securities” under SLUSA. The plaintiffs conceded that all other preclusion elements were satisfied.
Accordingly, the court held that SLUSA barred the plaintiffs’ state law class action claims and dismissed the complaint with prejudice.
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