Introduction

Two recent opinions from the Eleventh Circuit and Southern District of New York rejecting securities fraud class action claims provide helpful guidance on the types of stock promotional activities that are legally permissible under the federal securities laws. Among other lessons, the decisions provide that an issuer (1) has no statutory duty under Section 17(b) of the Securities Act of 1933 (“Securities Act”) to disclose promotional payments made to third-party publishers and (2) cannot be held liable under Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5(b) for any misleading statements or omissions in promotional articles unless the issuer itself has “made” the statement under the Supreme Court’s test in Janus Capital Group v. First Derivative Traders.[1]

Background

Both cases concern alleged stock promotional activities by biopharmaceutical companies touting their drug developments. The promotional activities took various forms including “flattering” articles, videos, interviews, and reports published by third-party stock promoters. The promotional campaigns allegedly coincided with or caused a rise in the stock prices of the companies. Subsequently, the stock prices allegedly fell dramatically upon news reports suggesting the companies had ties to the stock promoters or were the beneficiaries of a “paid-promotion scheme.”

The Decisions

In re Galectin Therapeutics, Inc. Securities Litigation

In Galectin, plaintiffs asserted Section 10(b) and Rule 10b-5 claims relating to Galectin’s payments to four stock promoters in exchange for favorable articles about the company at or about the time it was conducting two public stock offerings. First, plaintiffs alleged the promoters were agents of the company and, as a result, Galectin assumed the promoters’ obligations under Section 17(b) of the Securities Act to disclose any consideration received in exchange for their promotion material. Since the promoters’ articles did not disclose that Galectin paid for their publication, the articles were materially misleading and violated Section 10(b) and Rule 10b-5(b).[2] Second, plaintiffs alleged that defendants had falsely represented in their own public filings they had not taken action that caused or resulted in the manipulation of its stock price because, inter alia, defendants paid promoters to tout the stock so as “to manipulate the price of its securities in order to generate capital with as little dilution as possible.”[3] Third, plaintiffs alleged that Galectin’s 10-K and 10-Q reports were misleading because defendants omitted that Galectin paid promoters “to publish highly exaggerated and manipulative articles” about the company.[4]

In affirming the dismissal of the Section 10(b) and Rule 10b-5 claims in their entirety, a unanimous Eleventh Circuit held as follows with respect to each of the three claims:[5]

  • The Stock Promotion Articles. The Eleventh Circuit held that plaintiffs’ claims based on alleged omissions in the stock promoters’ articles were foreclosed by the Supreme Court’s decision in Janus. Under Janus, “the maker of a statement is the person or entity with ultimate authority over the statement, including the content and whether and how to communicate it.”[6] Applying that test, the Eleventh Circuit held that “payment for the promotional articles does not mean that Galectin is the maker of the statements in the articles.” Moreover, although plaintiffs alleged that defendants “worked in conjunction with stock promoters to promote Galectin’s stock,” they failed to include “sufficient allegations to support a finding that Galectin had ‘ultimate authority’ or ‘control’ over the stock promoters’ statements.”[7]
  • Representation of “No Manipulation” of Stock Price. The Eleventh Circuit rejected plaintiffs’ “no manipulation” claim because there is “nothing in the securities laws” that prohibits Galectin from hiring stock promoters or imposes a duty on an issuer to disclose payments for such promotional activities.[8] Instead, “[u]nder § 17(b) of the Securities Act, the duty to disclose promotional payments lies with the parties that receive the payments for promotion activities,”[9] i.e., the stock promoters. Moreover, “market manipulation” is a “term of art” under the securities laws and generally refers “to practices … that are intended to mislead investors by artificially affecting market activity.”[10] Thus, the Eleventh Circuit found that “defendants’ lawfully engaging third parties to ‘promote’ the Galectin stock through publications of boastful but truthful articles is not stock price ‘manipulation’ as a matter of law.”[11]
  • The Payment Omission Claim. The Eleventh Circuit held that Galectin’s omission regarding payments to stock promoters did not render its public filings misleading. Galectin’s reporting of shares sold, the price per share, and net proceeds from stock offerings in those filings did not trigger a duty for Galectin to disclose it had paid for stock promotion because a “reasonable securities investor” would not conclude from the disclosure of this information, without more, “that Galectin was in some way certifying or representing that it had not paid promoters to tout its stock to potential investors.”[12]

Cortina v. Anavex Life Sciences Corp.

In Cortina, plaintiffs alleged that “[d]efendants engaged in ‘an extreme stock promotion and market manipulation scheme’ to inflate the price of Anavex’s stock.”[13] The scheme included one promoter publishing interviews with Anavex’s CEO and clinical trial investigator.[14] Additionally, defendants allegedly did not disclose in the risk disclosure sections of their public filings that they were “behind” the paid-promotion scheme.[15]

In dismissing defendants’ market manipulation claims under Rule 10b-5(a) and (c), and material misrepresentations or omissions under Rule 10b-5(b), the Court stated as follows:[16]

  • The Market Manipulation Claims. Accusations that defendants “caused, directed, and authorized” a paid promotional scheme failed to meet the heightened pleading standards for fraud under Federal Rule of Civil Procedure 9(b). In particular, the Court held that (1) third-party statements in the promotional materials did not directly implicate the defendants; and (2) allegations that did relate to the defendants, including the promotional interviews with company officials and “Anavex’s generic desire to keep its stock price high,” were “patently insufficient” to allege that defendants “orchestrated” a paid-promotional scheme.[17] In addition, cases cited by plaintiffs that had upheld market manipulation claims were distinguishable because in those cases there were particularized allegations that “defendants had personally reviewed, edited, and approved the promotional pieces before they were published; forbade the promoters from disclosing their involvement in the articles; executed surreptitious stock transactions to enrich themselves; and even took steps to cover up their fraudulent dealings.”[18]
  • The Misrepresentation or Omission Claims. The Court characterized as “wise” plaintiffs’ decision not to base their misrepresentation or omission claims on the promotional statements themselves because the “vast majority … were made by third parties,” and under Janus those statements were not actionable.[19] In addition, plaintiffs failed to plausibly allege a fraudulent omission claim in relation to Anavex’s risk disclosures because (1) no paid-promotional scheme had been adequately alleged; (2) there was no duty under Section 17(b) of the Securities Act for an issuer to disclose promoter payments; and (3) unlike cases that had held there was a duty of disclosure based on an issuer’s “detailed list of factors that could explain stock price fluctuations,” Anavex’s risk disclosure “included only a generic, boilerplate description of why over-the counter stocks tend to be volatile investments” and such a “statement did not create a duty to disclose if Defendants had engaged in a paid-promotional scheme.”[20]

Ramifications

Developments in this area of the law continue to unfold as, prior to the Galectin decision, no circuit court had fully discussed the intersection of stock promotion activities and Section 10(b) and Rule 10b-5 violations, while the Cortina decision is the most comprehensive of its kind in the Southern District of New York and could be appealed. Nevertheless, the decisions provide some helpful principles in the stock promotion arena. First, applying Janus, courts will closely scrutinize exactly who the person or entity is with “ultimate authority” over statements made in promotional materials. This will include examining who was responsible for reviewing, editing, and approving the materials at issue. In this regard, generic allegations that an issuer “caused” a promotional effort to take place or that promoters were agents of the issuer, without more specifics, will likely be insufficient. Second, the decisions reaffirm the principle that there is no legal duty for an issuer to disclose promotional payments under Section 17(b) of the Securities Act. Third, the level of detail contained in an issuer’s risk and other related disclosures will be an important consideration when a court evaluates whether a duty to disclose a paid stock promotion was triggered. Issuers therefore should carefully evaluate the scope and extent of their public disclosures in determining whether the absence of reporting payments to promotional third-parties would render another reported statement misleading.