2012 Year-End Securities Law Compendium - Latham & Watkins

2012 Year-End Securities Law Compendium

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TABLE OF CONTENTS

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PREFACE ........................................................................................................................................1

I. RECENT SUPREME COURT DECISIONS ......................................................................2

A. Class Certification ....................................................................................................2 1. Amgen Inc. v. Connecticut Retirement Plans & Trust Funds, 133 S.

Ct. 1184 (2013) ............................................................................................2 B. Statute of Limitations ...............................................................................................2

1. Credit Suisse Securities (USA) LLC v. Simmonds, 132 S. Ct. 1414 (2012) ...........................................................................................................2

2. Gabelli v. SEC, 568 U.S. 133 (2013) ...........................................................3

II. FIRST CIRCUIT ..................................................................................................................4

A. SUMMARY OF DEVELOPMENTS DURING 2012 ............................................4 B. NOTEWORTHY CASES DURING 2012 ..............................................................4

1. Misstatements and Omissions ......................................................................4 2. Scienter ........................................................................................................7 3. Loss Causation .............................................................................................8

III. SECOND CIRCUIT.............................................................................................................9

A. SUMMARY OF DEVELOPMENTS DURING 2012 ............................................9 B. NOTEWORTHY CASES DURING 2012 ............................................................10

1. Misstatements or Omissions ......................................................................10 2. Scienter ......................................................................................................12 3. Loss Causation ...........................................................................................15 4. Statute of Limitations .................................................................................17 5. Standing/Extra-Territorial Application of the Securities Laws .................17 6. Item 303 Disclosure Obligations ...............................................................19 7. Class Action Certification ..........................................................................20 8. Class Action Fairness Act ..........................................................................20 9. Short Swing Profits ....................................................................................21 10. Substantial Assistance ................................................................................21 11. Dodd-Frank/Whistleblower Protection ......................................................22

IV. FIFTH CIRCUIT ...............................................................................................................24

A. NOTEWORTHY CASES IN 2012 ........................................................................24 1. Pleading Standards for Securities Fraud ....................................................24

V. SIXTH CIRCUIT ...............................................................................................................25

A. SUMMARY OF DEVELOPMENTS DURING 2012 ..........................................25

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B. NOTEWORTHY CASES DURING 2012 ............................................................25 1. Misstatements and Omissions ....................................................................25 2. Materiality ..................................................................................................26 3. Statute of Limitations .................................................................................28 4. SLUSA .......................................................................................................28

VI. SEVENTH CIRCUIT ........................................................................................................30

A. SUMMARY OF DEVELOPMENTS DURING 2012 ..........................................30 B. NOTEWORTHY CASES DURING 2012 ............................................................30

1. Pleading Standards for Securities Fraud ....................................................30 2. Scienter ......................................................................................................32 3. SLUSA .......................................................................................................33

VII. NINTH CIRCUIT ..............................................................................................................34


1. Pleading Standards for Securities Fraud ....................................................34 2. Misstatements and Omissions ....................................................................38 3. Scienter ......................................................................................................39 4. Loss Causation ...........................................................................................41 5. Demand Futility / Business Judgment Rule ...............................................42

VIII. TENTH CIRCUIT .............................................................................................................43


1. Scienter ......................................................................................................43 2. Class Action Certification ..........................................................................43 3. Primary Liability ........................................................................................44

IX. ELEVENTH CIRCUIT ......................................................................................................45


1. Misstatements and Omissions ....................................................................45 2. Scienter ......................................................................................................46 3. Loss Causation ...........................................................................................46

X. D.C. CIRCUIT ...................................................................................................................48

1. Scienter ......................................................................................................48

XI. DELAWARE COURTS ....................................................................................................49


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1. Fiduciary and Revlon Duties ......................................................................49 2. Books and Records Inspection ...................................................................54 3. Breach of Contract .....................................................................................54 4. Fraudulent Misrepresentation ....................................................................55 5. Entire Fairness ...........................................................................................56 6. Demand Futility .........................................................................................56 7. Action to Compel a Meeting of Stockholders............................................57 8. Action for Advancement of Legal Fees and Expenses ..............................57

XII. SEC RULES AND GUIDANCE .......................................................................................58

A. SUMMARY OF DEVELOPMENTS DURING 2012 ..........................................58 B. NOTEWORTHY RULES AND GUIDANCE ISSUED BY THE SEC

DURING 2012 .......................................................................................................58 1. SEC Modifies “Neither Admit Nor Deny” Policy .....................................58 2. SEC Designates BATS Securities as Covered Securities ..........................58 3. SEC Tightens Rule on Advisory Performance Fee Charges .....................58 4. SEC Adopts Exemptions for Security-Based Swaps .................................59 5. SEC and CFTC Adopt Rules Defining “Security-Based Swap

Dealer” and “Major Swap Participant” ......................................................59 6. CFTC Adopts Reporting Rule for Pre-Dodd-Frank Swap

Transactions ...............................................................................................60 7. SEC Adopts Rule Requiring Exchanges to Adopt Listing Standards

on Compensation .......................................................................................60 8. SEC Adopts Dodd-Frank Act Procedures to Review Clearing

Submissions ...............................................................................................61 9. SEC and CFTC Adopt Final Rules of Key Definitions Regarding

Financial Instruments .................................................................................61

XIII. DEVELOPMENTS WITH THE PUBLIC COMPANY ACCOUNTING OVERSIGHT BOARD DURING 2012 ............................................................................63

A. SUMMARY OF DEVELOPMENTS DURING 2012 ..........................................63 B. NOTABLE RELEASES DURING 2012...............................................................63

1. PCAOB Enters into Cooperative Agreements with the German and Spanish Audit Regulators ..........................................................................63

2. PCAOB Adopts Auditing Standard No. 16, Communications with Audit Committees, and Amendments to Other Standards ..........................63

C. NOTABLE DISCIPLINARY PROCEEDINGS DURING 2012 ..........................64 1. PCAOB Announces Settled Disciplinary Orders for Audit Failures

Against a Big Four Audit Firm and Four of its Partners ...........................64

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PREFACE

Latham & Watkins’ Securities Litigation and Professional Liability Practice presents its annual Year-End Securities Law Compendium. The 2012 Compendium highlights noteworthy trends from the past year in the areas of federal securities law, Delaware corporate litigation, and Securities and Exchange (SEC) and Public Company Accounting Oversight Board (PCAOB) enforcement activity and rule-making. All told, the 2012 Compendium contains:

• Over 75 case summaries from the US Supreme Court and every federal circuit in the US;

• Summaries of more than 20 decisions from the Delaware state courts; and

• Over 12 summaries of SEC enforcement actions and PCAOB disciplinary proceedings, as well as key releases and guidance issued by the SEC and PCAOB.

Latham’s Securities Litigation and Professional Liability lawyers closely monitor developments in these areas throughout the year, circulating concise summaries of all noteworthy decisions and news on a real-time basis. Every year, we compile the most important of these summaries into the Compendium. We present this document as a valuable resource for practitioners and organizations involved or interested in securities litigation and enforcement.

Highlights from the Supreme Court and each circuit, as well as Delaware and the enforcement agencies, are discussed at the outset of each section. The Compendium also discusses the Supreme Court’s recent landmark decision in Amgen Inc. v. Connecticut Retirement Plans & Trust Funds, as well as the Court’s 2013 decision in SEC v. Gabelli. The Compendium also tracks trends, circuit-by-circuit, in a variety of substantive areas arising out of shareholder class actions, M&A litigation, enforcement matters and other federal cases. The Compendium provides insight into the cases arising out the recent financial crisis, as those cases continue to work their way through the federal courts. The regulatory section of the Compendium highlights developments with respect to the SEC’s new whistleblower program, its creation of Dodd-Frank regulations, and tightened standards and releases issued by the SEC and PCAOB with respect to reverse mergers.

If you would like to discuss the Compendium, or learn more about Latham’s Securities Litigation and Professional Liability Practice, please contact one of the editors listed below, any member of the group or your lawyer contact at the firm. For a global roster of our Securities Litigation and Professional Liability Practice, please visit the firm’s website at www.lw.com.

Robert J. Malionek +1.212. 906.1816 [email protected] New York

Kevin M. McDonough +1.212.906.1246 [email protected] New York

Jennifer Greenberg +212.906.1871 [email protected] New York

http://www.lw.com/

mailto:[email protected]



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I. RECENT SUPREME COURT DECISIONS

A. Class Certification

1. Amgen Inc. v. Connecticut Retirement Plans & Trust Funds, 133 S. Ct. 1184 (2013)

Plaintiff brought claims under the Securities Exchange Act of 1934 (the Exchange Act) against officers of a biotechnology company, alleging that they made material misstatements about the results of a clinical trial. Plaintiff moved for class certification, and the district court held that plaintiff’s allegation that the misstatements were material was sufficient to invoke the fraud-on-the-market theory. The district court rejected defendants’ argument that plaintiff must prove materiality at the class certification stage, and denied them an opportunity to present evidence to rebut materiality. The Ninth Circuit affirmed, reasoning that these issues go to the merits of the case and should be resolved on summary judgment or at trial. The Supreme Court granted certiorari to consider whether, in a misrepresentation case under Rule 10b-5, the district court must require proof of materiality before certifying a class based on the fraud-on-the market-theory and whether the district court must allow the defendant an opportunity to present evidence to rebut the fraud-on-the-market theory. In a six to three decision, the Court affirmed the Ninth Circuit's finding that plaintiffs in a securities fraud action need only plausibly allege — not prove — that allegedly misleading statements are material in order to win class certification. In so holding, the Court rejected defendant’s argument that proof of materiality was a prerequisite for winning class status, finding that the approach defendant advocated would force courts to engage in “mini-trials” on the merits at an inappropriately early stage of litigation.

B. Statute of Limitations

1. Credit Suisse Securities (USA) LLC v. Simmonds, 132 S. Ct. 1414 (2012)

Plaintiff filed suit against the underwriters of various IPOs, claiming that they employed mechanisms to inflate the aftermarket price of the issued stock, creating “short-swing” profits, and triggering Section 16(b) of the Exchange Act. Defendants claimed the suit was untimely because Section 16(b)’s two-year statute of limitations had run out. Plaintiff claimed the statute was tolled because the underwriters were subject to, and failed to comply with, Section 16(a)’s reporting requirements. Defendants argued that Section 16(b)’s limitations period is a statute of repose that does not toll. The district court dismissed plaintiff’s complaint on the ground that Section 16(b)’s two-year statute of limitations had expired. The Ninth Circuit reversed, holding that the Section 16(b) limitations period does not establish a period of repose but is “tolled until the insider discloses his transactions in a Section 16(a) filing, regardless of whether the plaintiff knew or should have known of the conduct at issue.” The Supreme Court was equally divided four to four (with Chief Justice Roberts not participating) on the issue of whether Section 16(b) establishes a period of repose, and thus is not subject to any tolling whatsoever. However, in a unanimous decision, the Court reversed the Ninth Circuit, and held that, even assuming Section 16(b)’s two-year period is a statute of limitations (not a statute of repose), the Ninth Circuit erred in determining that the two-year period is tolled until a Section 16(a) statement is filed. In support of its holding, the Court looked to the language of Section 16(b), which states that the two-year clock starts from “the date such profit was realized” and found that the Ninth Circuit’s

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rule should not apply because it conflicts with “long-settled equitable-tolling principles.” In a concealment-of-fraud case, the Court noted, the statute of limitations does not begin to run “until discovery of the fraud where the party injured by the fraud remains in ignorance of it without any fault or want of diligence on his part.” The Court stated that allowing tolling to continue beyond discovery of the fraud, which would be the result of the Ninth Circuit’s holding, is inequitable and inconsistent with the purpose of statutes of limitations — “to protect defendants against stale or unduly delayed claims.” The Court remanded the case for the lower courts to apply the standard rules of equitable tolling.

2. Gabelli v. SEC, 568 U.S. 133 (2013)

The SEC filed a complaint against a portfolio manager and Chief Financial Officer (CFO), claiming that they violated the Investment Advisors Act of 1940 (the Investment Advisors Act) by permitting an investor to make late trades at the expense of other investors. The SEC alleged that late trading, which occurs when US mutual fund shares are bought, redeemed or exchanged after the market closes at 4 p.m. and allows a party to receive the current day’s mutual fund price, negatively affects long-term fund investors. The SEC filed its complaint in 2008, but based its claims on conduct that occurred in the period of September 1999 to August 2002. Defendants argued that the SEC’s action was untimely, based on a section of the US Code stating that the government may bring an action for civil penalties only within five years of the date its claim “first accrued.” Defendants argued that the fraud accrued no later than 2002 (the latest date of the alleged misconduct), while the SEC argued that its claim accrued when it discovered the alleged fraud in 2003, five years before filing suit. Reading a “discovery” rule into the statute, the Second Circuit held that an SEC fraud claim first accrues when the agency discovers or should have discovered the misconduct under the Investment Advisers Act. In a unanimous ruling, the Supreme Court overturned the Second Circuit’s decision, finding that five-year limitation on the SEC’s claim against defendants had expired prior to the commencement of suit in 2008. The Court further found that the SEC was not entitled to a stay on bringing action against the defendants, as such a stay was only valid when private citizens discover a concealed fraud long after it has been perpetrated and in the rare instances when the government was the victim of a concealed fraud. In this regard, the Court observed that the SEC and other government agencies charged with finding and rooting out fraud and have powerful investigative tools at their disposal, and thus do not have the same right to a discovery stay as private citizens do.

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II. FIRST CIRCUIT

A. SUMMARY OF DEVELOPMENTS DURING 2012

The First Circuit and the District of Massachusetts issued a number of interesting federal and state securities law decisions this past year, particularly in the areas of materiality, scienter and loss causation. In In re Smith & Wesson Holding Corp. Securities Litigation, the First Circuit held that a positive statement regarding sales, coupled with a pattern of ‘accelerating’ demand for its products through sales promotions, did not give rise to an actionable misstatement, let alone misstatements with the requisite scienter to sustain a claim for securities fraud. Regarding scienter, the First Circuit held in Automotive Industries Pension Trust Fund v. Textron Inc. that overly-positive disclosures regarding a company’s order backlog could be material, but nonetheless dismissed the complaint as plaintiffs could not allege that defendants intentionally failed to disclose accurate information. In the In re Boston Scientific Corp. Securities Litigation, the First Circuit affirmed the dismissal of securities fraud claims, holding that that various statements made by management related to growth projections, and a government investigation related to defendant’s charitable contributions were either immaterial or did not give rise to a sufficient inference of scienter. On the topic of loss causation, in Bricklayers & Trowel Trades International Pension Fund v. Credit Suisse First Boston, the District of Massachusetts quashed plaintiff’s expert report, and granted summary judgment to defendants, where plaintiffs’ report did not accurately account for corrective disclosures, restatements of previously disclosed information, and other factors necessary to demonstrate a causal link between defendant’s disclosures and its stock price.

B. NOTEWORTHY CASES DURING 2012

1. Misstatements and Omissions

a. In re Smith & Wesson Holding Corp. Securities Litigation, 669 F.3d 68 (1st Cir. 2012)

A class of investors brought suit against defendant firearms company and two of its officers under Sections 10(b) and 20(a) of the Exchange Act for allegedly “issu[ing] false or misleading public statements about the demand for its products” in June and September 2007. In affirming the district court’s grant of summary judgment for the company, the First Circuit held that plaintiffs’ evidence demonstrated a debatable case as to misstatements and omissions and failed to show evidence of scienter. The court found that plaintiffs failed to demonstrate a genuine dispute of material fact regarding the company’s June 2007 statements. Plaintiffs’ evidence regarding missed sales goals was, at best, “mixed,” and plaintiffs also failed to show that discounts offered by defendants amounted to “channel stuffing.” As to the alleged September 2007 misstatements, the court noted the possibility that a short drop-off in sales in August 2007 should have been disclosed. Nonetheless, summary judgment was proper because plaintiffs presented no evidence of fraudulent intent. That defendants failed to disclose a decline in demand in the month previous to their September 2007 statement could have been a negligent misjudgment and, without more, did not warrant an inference of culpable recklessness.

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b. In re Boston Scientific Corp. Securities Litigation, 686 F.3d 21, (1st Cir. Mass 2012)

Plaintiff investors alleged that defendant company and its management had committed securities fraud under Sections 10(b) and 20(a) of the Exchange Act because defendants failed to mention that two percent of the sales representatives in one department were under investigation (and ultimately fired) for misuse of corporate expense accounts, and that the company was subject to a subpoena by the US Department of Health and Human Services. The First Circuit held that these alleged misstatements failed to meet the materiality threshold because they dealt with a small percentage (10 out of 1,100) of company’s sales force. The court further held that the failure to disclose these facts did not render statements about the growth of its sales and its sales force from being materially misleading. Finally, the First Circuit found that plaintiffs failed to adequately allege scienter with respect to the chief executive officer’s (CEO’s) allegedly material omissions regarding the fired employees (in conjunction with positive statements about its sales force). In order to satisfy the Private Securities Litigation Reform Act’s (PSLRA’s) requirement for pleading scienter, plaintiffs were required, but failed, to allege facts sufficient to support an inference that the CEO knowingly withheld material information, or allege that the information was so important to the company that the court could thus infer that the CEO was reckless in not mentioning it.

c. Washtenaw County Employees’ Retirement System v. Princeton Review Inc., No. 11 Civ. 11359, 2012 WL 727125 (D. Mass. Mar. 6, 2012)

Investors brought suit against defendant test preparation company, several of its officers and directors and its underwriter, alleging that defendants materially misrepresented or failed to disclose in its offering materials that (i) the company’s internal data suggested poor future financial results, (ii) increases in customer enrollment in its courses were insufficient to counteract consumers’ shift to less expensive products, (iii) the company’s revenues were negatively impacted by increased competition and management’s pursuit of side projects and (iv) the company was not executing on its business plan. The court granted the company’s motion to dismiss with prejudice finding that plaintiffs did not sufficiently allege the existence of an actionable misrepresentation or omission.

First, the company’s failure to warn of poor quarterly results did not constitute an actionable omission because the company had no duty to disclose its “internally-tracked advance booking information.” The court noted that plaintiffs did not allege that, at the time of its stock offering, the company knew or had internal information guaranteeing that its third quarter results would be disappointing. Second, the company fully disclosed the effects of customers’ shift to low priced offerings; indeed, the company’s “boilerplate” language describing the risk was sufficient because it warned of the exact risk that occurred. The decline in stock price following the company’s November announcement of its quarterly financial results was insufficient to show that the company’s original disclosure was inadequate because the company’s stock price had already fallen by over 50 percent between April and November. Third, the court found sufficient the company’s disclosures that it faced “intense” and “increased” competition, and it would engage in certain side projects. In this regard, the court found that a company does not need to disclose facts “in the bleakest possible terms in order to make its disclosures complete.”

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Finally, with respect to alleged misstatements regarding the company’s business plan, the court found that, standing alone, the CEO’s optimistic statements regarding the execution of the company’s strategy were insufficient to create an actionable misrepresentation under the Securities Act.

d. Massachusetts Mutual Life Insurance Co. v. Residential Funding Co., LLC, 843 F. Supp. 2d 191 (D. Mass. 2012)

Plaintiff investor brought claims against dozens of financial institutions and their directors and officers pursuant to diversity jurisdiction under Sections 410(a) and (b) of the Massachusetts Uniform Securities Act in connection with plaintiff’s purchase of residential mortgage-backed securities from defendants. Plaintiff alleged that defendants made material misstatements in their offering documents regarding their underwriting guidelines for loan origination, and the appraisals, loan-to-value ratios and owner-occupancy rates of the homes that formed the collateral for the securities that plaintiff purchased. The court held that plaintiff’s allegations of “widespread abandonment of the underwriting guidelines” by defendants were sufficient to support a claim that defendants made misstatements with respect to the underwriting guidelines used by the loan originators. Second, plaintiff adequately alleged misstatements regarding defendants’ appraisal practices, which diverged from their disclosures, and the valuations contained in the offering materials. Further, the court held that defendants’ statements that housing values may change did not put plaintiff on notice that the appraisals themselves were false at the time of loan origination. However, the court dismissed (i) plaintiff’s claims regarding the accuracy of owner-occupancy rates as to those defendants who disclosed that the rates were derived only from borrower representations and (ii) plaintiff’s claims against all non-underwriter defendants, because they were not “sellers” under Massachusetts law.

e. In re Novell, Inc. Shareholder Litigation, No. 10 Civ. 12076, 2012 WL 458500 (D. Mass. Feb. 10, 2012)

Former shareholders of target company claimed that defendant company’s former directors breached their fiduciary duties when they failed to maximize shareholder value in connection with a merger, that the acquiror aided and abetted defendants’ breach, and that all defendants violated Sections 14(a) and 20(a) of the Exchange Act by making material misstatements or omissions in the target company’s proxy materials. The court dismissed all claims against the acquiror, finding that plaintiffs failed to allege facts that would establish aiding and abetting liability or liability for material misstatements or omissions contained in the proxy materials. The court stayed the proceedings against the company’s directors under the Colorado River abstention doctrine in favor of an earlier-filed matter pending in Delaware Chancery court, on the basis that doing so would avoid piecemeal litigation while still protecting the parties’ rights.

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2. Scienter

a. Automotive Industries Pension Trust Fund v. Textron Inc., 682 F.3d 34 (1st Cir. 2012)

Plaintiff investors brought a class action lawsuit against defendant aircraft company and several of its officers under Sections 10(b) and 20(a) of the Exchange Act for allegedly omitting material information in several statements to investors. The district court granted the company’s motion to dismiss for failure to state a claim on the basis of lack of materiality; the First Circuit affirmed on the separate grounds that plaintiffs did not sufficiently allege scienter. The First Circuit held that company’s rosy statements in 2007 and 2008 — about a large backlog of orders and lower than usual cancellations when the company had weakened its underwriting standards in early 2007 — presented a close call on materiality, and that this issue was better left for summary judgment. However, the court held that plaintiffs failed to plead facts suggesting that the company or its officers believed or were recklessly unaware that the company’s allegedly weaker underwriting standards undermined the significance of the order backlog. The failure to plead such facts, coupled with alleged misstatements that were of questionable materiality, led to the First Circuit to conclude that investors had failed to adequately allege scienter.

b. Urman v. Novelos Therapeutics, Inc., No. 10-10394, 2012 WL 2149565 (D. Mass. June 11, 2012)

Plaintiff investors brought a securities class action lawsuit against defendant company and its CEO, alleging that the CEO made false and misleading statements — in violation of Sections 10(b) and 20(a) of the Exchange Act — regarding the company’s drug trials. In particular, plaintiffs alleged that statements touting defendant company’s drug based on prior trials were materially misleading because the company had substantially modified the manufacturing process and chemical composition of the drug before a Phase 3 clinical trial. The court granted defendants’ motion to dismiss, holding that plaintiffs’ allegations were insufficient to support an inference that the CEO knew (or was reckless with respect to the fact) that the chemical alteration would impact the efficacy of the drug. Based on plaintiffs’ allegations, there was in the court’s view an equally compelling inference that the CEO believed the chemical changes would affect the color of the drug. The court also noted that numerous experts at the FDA were aware of the proposed changes to the drug’s composition and apparently deemed those changes immaterial. The court further concluded it was implausible to infer that company would knowingly alter a drug that was well along on the path to success. Plaintiffs also failed to present sufficient allegations of loss causation. As the court observed, (i) the company’s stock price increased after the alleged misstatements were disclosed to the market and (ii) the decrease in stock price accompanying company’s disclosure of the poor Phase 3 results could not have been caused by the alleged misstatements about the chemical changes, since the chemical changes were not disclosed at that time.

c. In re Genzyme Corp., No. 09 Civ. 11267 & 11299, 2012 WL 1076124 (D. Mass. Mar. 30, 2012)

A class of investors claimed that defendant company and some of its executives and officers violated Sections 10(b) and 20(a) of the Exchange Act by making material

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misrepresentations or omissions regarding three issues arising during the class period. The court dismissed all claims against defendants, finding that the complaint did not contain allegations sufficient to support an inference of scienter. First, although the company did not disclose the failure of two of its bioreactors, no allegation was made that the company knew of and failed to disclose the cause of this failure. Second, observations made by the FDA regarding noncompliance of the company’s manufacturing practices did not constitute material information that had to be disclosed because the observations were preliminary and only a precursor to more substantial agency action. Third, plaintiffs failed to show that the defendants knew the company’s measures to resolve the FDA’s concerns were inadequate and would delay FDA’s approval of the company’s new drug.

3. Loss Causation

a. Bricklayers & Trowel Trades International Pension Fund v. Credit Suisse First Boston, No. 02 Civ. 12146, 2012 WL 118486 (D. Mass. Jan. 13, 2012)

Plaintiff investors brought a class action suit against defendant investment bank and several of its officers and research analysts for allegedly releasing reports containing material misstatements and omissions in violation of Sections 10(b) and 20(a) of the Exchange Act. Defendants moved to preclude plaintiffs’ expert witness’s testimony and event study as insufficiently reliable to prove loss causation and damages. The court agreed that the expert’s event study was inadmissible for several reasons, and, sua sponte, granted summary judgment to defendants on all claims. First, the study ignored 22 of 34 days in which alleged misstatements were made and erroneously classified disclosures as corrective or inflationary. Second, the study’s “baseline” ignored every day that any report about defendant bank was released during the class period (accounting for 54 percent of the class period), which caused company stock to appear less volatile. The expert also linked stock declines to defendants’ statements even when their reports merely parroted previous information. Finally, the expert did not correctly control for “confounding factors” — other company-related news released on the same day as alleged misstatements or corrections — that could also account for price volatility. The court further concluded that the expert’s report was insufficient to create an issue of fact regarding loss causation because plaintiffs failed to “isolate the extent to which the decrease in stock price was caused by the disclosure” and not other factors.

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III. SECOND CIRCUIT


The Second Circuit issued numerous significant securities laws decisions in 2012, covering a vast array of topics, including the requirements for pleading falsity, standing, and the proper interpretation of Item 303 of Regulation S-K. In City of Omaha, Nebraska Civilian Employees’ Retirement System v. CBS Corp. and Bricklayers & Masons Local Union No. 5 Ohio Pension Fund v. Transocean Ltd., the Court reaffirmed its earlier decision in Fait v. Regions and held that for an opinion statement to be actionable, plaintiff must allege subjective falsity, i.e. that the defendant disbelieved the opinion at the time it was issued. In CBS Corp. and Transocean Ltd., the Court applied this standard in the context of a goodwill valuation and a merger fairness opinion, respectively.

In Goldman Sachs v. NECA-IBEW Health & Welfare Fund, the Second Circuit found that a plaintiff could represent members of a class with respect to certain offerings of securities, even if the plaintiff did not purchase in those offerings and would not have standing to pursue a claim by itself, as long as the claims for which the plaintiff did have standing and the claims of the absent class members implicate substantially the same set of concerns. On the issue of standing to pursue claims relating to foreign transactions, the Court interpreted the Supreme Courts’ landmark Morrison decision and held in Absolute Activist Value Master Fund Ltd. v. Ficeto that a “domestic transaction, which gives rise to liability under the federal securities laws, occurs when the parties incur irrevocable liability to carry out the transaction within the US, or when title is passed within the US. Later, in SEC v. Tourre, the Southern District of New York, the Court held that a US-based transfer of title between two parties, neither of whom was the party upon which the alleged fraud was perpetrated, did not satisfy Section 10(b)’s requirement that the alleged fraud be “in connection with” an offending domestic transaction because for Section 10(b) to apply, the domestic securities transaction must be the alleged fraudulent transaction. The Southern District of New York addressed the extraterritorial application of the securities laws again in In re Optimal U.S. Litigation, finding that, in light of the presumption against the extraterritorial application of the Exchange Act following Morrison and the attenuated relationship between the foreign plaintiffs’ investment and domestic securities, foreign plaintiffs’ investments in a foreign investment fund which in turn invested all its assets with Bernard Madoff, were not sufficiently “in connection with” the purchase of domestic securities to implicate liability under the Exchange Act.

In Panther Partners Inc. v. Ikanos Communications Inc., the Second Circuit interpreted Item 303 of Regulation S-K, and clarified that the focus of that regulation is not necessarily disclosure based on current impact of an adverse event or condition, but rather on whether the uncertainty surrounding the event or condition might reasonably be expected to have a material impact on future revenues.

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1. Misstatements or Omissions

a. City of Omaha, Nebraska Civilian Employees Retirement System v. CBS Corp., No. 11-2575-cv, 2012 WL 1624022 (2d Cir. May 10, 2012)

Plaintiff investors brought a putative class action against defendant nationwide media corporation and certain of its officers, alleging that defendants violated Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 by making misleading statements regarding the media corporation’s revenue and the value of its goodwill. Specifically, plaintiffs alleged that defendants’ statements regarding the value of the corporation’s goodwill prior to the third quarter of 2008 were false because defendants were aware of facts that should have prompted the corporation to perform an interim impairment test on its existing goodwill two quarters prior to when it actually conducting said test, which resulted in a $14 billion non-cash impairment charge during the third quarter of 2008. The district court granted defendants’ motion to dismiss, and the Second Circuit affirmed. The court held that estimates of a corporation’s goodwill valuation are merely opinion because goodwill is not a matter of objective fact. Therefore, in order to plead an actionable misstatement, plaintiffs were required to allege that defendants did not believe their statements regarding goodwill at the time they were made. The court found that plaintiffs’ allegations regarding the media corporation’s knowledge of the downward trajectory of its market capitalization, declining advertising revenues for some reporting units, conservative analyst expectations, and the media corporation’s own anticipation of an economic slowdown failed to plausibly demonstrate that the media corporation should have known that earlier interim impairment testing was warranted. Moreover, even if plaintiffs had adequately demonstrated that defendants knew that interim impairment testing was warranted, the court found that plaintiffs failed to demonstrate that defendants did not believe their statements regarding the media corporation’s goodwill at the time such statements were made. In addition, because the information that plaintiffs alleged should have led the media corporation to perform earlier interim impairment testing was public knowledge reflected in the media corporation’s stock price at all pertinent times, the court held that plaintiffs failed to adequately allege that plaintiffs relied on the stock’s fraudulently inflated price.

b. Finn v. Barney, No. 11-1270-CV, 2012 WL 1003656 (2d Cir. Mar. 27, 202)

The Second Circuit considered whether the Southern District of New York erred in dismissing plaintiff investors’ complaint on the basis that the plaintiffs failed to adequately plead manipulative conduct or reasonable reliance. The plaintiffs’ complaint alleged that the defendant financial corporation violated Sections 10(b) and 20(a) of the Exchange Act when it intervened in auction rate securities (ARS) auctions that plaintiffs believed were based on simple supply and demand, rather than interference by the defendant. The Second Circuit affirmed the district court’s dismissal of the complaint, finding that the disclosures made by defendant financial corporation plainly stated that it “may routinely” place bids in ARS auctions, which is precisely what the defendant then did. Because the transaction’s terms were fully disclosed, the allegation of misrepresentation was properly dismissed. The court distinguished this case from prior cases,

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where the plaintiff alleged that defendant had supported bids in every ARS auction, rather than just some of the auctions. Even still, the court found that the defendant financial corporation’s disclosures likely would have covered that instance as well.

c. Bricklayers & Masons Local Union No. 5 Ohio Pension Fund v. Transocean Ltd., No. 10 Civ. 7498, 2012 WL 1080366 (S.D.N.Y. Mar. 30, 2012)

Investors brought a putative class action against defendant offshore oil contractor and certain of its officers, alleging that defendants violated Sections 14(b) and 20(a) of the Exchange Act by distributing a joint proxy statement containing false and misleading statements in connection with a merger. Defendants moved to dismiss, and the court granted that motion in part. As a threshold matter, the court held that plaintiffs’ Section 14(a) allegations sounded in fraud and thus were subject to the heightened pleading standards of Rule 9(b). The court found, however, that the PSLRA pleading requirements did not apply because Section 14(a) only require a showing of negligence, which is not a “state of mind.” Next, the court found that plaintiffs adequately pled that the proxy statement contained material misrepresentations regarding the defendants’ compliance with all applicable environmental laws, among other things. Plaintiffs also adequately pled subjective falsity with respect to the fairness opinion incorporated in the proxy statement because plaintiffs alleged provable facts supporting a strong inference that defendants did not believe the opinion. In particular, plaintiffs alleged that the firms who issued the fairness opinion relied on the merger agreement that defendants allegedly knew were false and misleading.

d. Richman v. Goldman Sachs Group, Inc., No. 10 Civ. 3461, 2012 WL 2362539 (S.D.N.Y. June 21, 2012)

Investors in an investment bank sued the bank and certain of its officers for fraud under Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5. Plaintiffs claimed that defendants failed to disclose their receipt of Wells Notices indicating that the bank was at risk of an SEC enforcement action with respect to its synthetic collateralized debt obligations (CDOs) and that the bank made material misstatements and omissions about its role in those offerings. Plaintiffs claimed damages resulting from a nearly 30 percent decline in the bank’s stock price after the SEC filed fraud charges and pursued investigations relating to the offerings. The court granted defendants’ motion to dismiss claims predicated on their failure to disclose receipt of the Wells Notices, holding that Regulation S-K, Item 103 does not impose a duty to disclose receipt of Wells Notices, and although FINRA and NASD rules do impose such a duty, securities fraud liability cannot be predicated on violation of these rules alone. Nor could the failure to disclose the Wells Notices support an allegation of scienter where defendants had no duty to inform investors. The court declined to dismiss claims based on defendants’ allegedly misleading statements regarding their role in the CDO offerings, holding that plaintiffs adequately alleged that representations made by the bank were incomplete and that the bank’s statements of compliance with the law and monitoring potential conflicts of interest were not mere corporate puffery. Further, the court held that plaintiffs plausibly plead scienter because the individual defendants were aware of the bank’s positions in the CDO transactions and of the resulting conflict of interest.

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e. In re ITT Educational Services, Inc. Securities & Shareholder Derivatives Litigation, No. 10 Civ. 8323, 2012 WL 1632762 (S.D.N.Y. May 4, 2012)

Plaintiff investors brought a putative class action under Sections 10(b) and 20(a) of the Exchange Act, and Rule 10b-5 against defendants, a private for-profit college system and certain of its officers, alleging misrepresentations by defendants, including statements about the college system’s positive financial results without reference to alleged predatory student enrollment practices that threatened continued Title IV tuition funding. Defendants brought a motion to dismiss, and the court granted the motion in its entirety. Because plaintiffs failed to plead facts sufficient to demonstrate that the college system received revenue from other sources, the court held that statements characterizing the source of revenue as increased recruiter training, more effective advertising, a commitment to student outcomes and increased demand for services were not misleading. The court held that the plaintiffs failed to plead facts sufficient to demonstrate that a material portion of the college system’s revenue was derived from sources other than those it claimed, and further found the company’s statements were not misleading if revenue was derived at least in part from claimed sources. The court rejected plaintiffs’ contention that defendants’ statements regarding the college system’s student employment rates were misleading absent a showing of an egregious discrepancy between actual and claimed enrollment, which is necessary to establish a substantial likelihood that proper disclosure would be viewed by a reasonable investor as significantly altering the mix of available information. The court also found that vague statements regarding the college system’s business focus were non-actionable corporate puffery unlikely to mislead investors. The court further held that broad statements pertaining to legal compliance are only misleading when a plaintiff can particularly and specifically establish widespread instances of noncompliance.

2. Scienter

a. Dodona I, LLC v. Goldman Sachs & Co., No. 10 Civ. 7497, 2012 WL 935815 (S.D.N.Y. Mar. 21, 2012)

Plaintiff brought a putative class action against defendant financial institution, its affiliates and two of its former employees, alleging violations of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5, as well as various state law claims. In particular, plaintiff alleged that defendants offered synthetic CDOs that referenced residential mortgage-backed securities through credit default swaps and then “shorted” the CDOs as part of a scheme to decrease defendants’ subprime exposure at the expense of its investors. Plaintiff also alleged that defendants failed to disclose this scheme and the fact that they did not believe that the CDOs would be profitable for investors. Defendants moved to dismiss, and the court granted the motion in part and denied it in part. As to plaintiff’s claim regarding material omissions, the court found that taken together, plaintiff’s factual allegations that defendants sought to unload subprime risk and knew that the assets referenced in the CDOs would likely lose value raised a strong inference of scienter. In addition, these allegations supported an inference that defendants had motive and opportunity to perpetrate the fraud. The court then found that plaintiff adequately pled an actionable omission by establishing that defendants had a duty to disclose that the CDOs did not have a realistic chance of being profitable. In addition, the question of whether plaintiff should have uncovered the alleged fraud using public information was a question of fact not fit for

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determination on a motion to dismiss. Finally, the court found that plaintiff adequately pled causation. The court dismissed plaintiff’s claim of market manipulation because plaintiff did not adequately allege that it relied on an efficient market free of manipulation. The court, however, held that plaintiff adequately alleged control person liability under Section 20(a) because plaintiff adequately pled a primary violation and alleged that two defendant institutions and the defendant employees each controlled a primary violator and were culpable participants in the alleged fraud.

b. Janbay v. Canadian Solar, Inc., No. 10 Civ. 4430, 2012 WL 1080306 (S.D.N.Y. Mar. 30, 2012)

Plaintiff investors brought a putative class action against defendant company and certain of its officers, alleging violations of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5. In particular, plaintiffs alleged that defendants made false statements regarding the company’s financial results and its system of internal controls in connection with the improper recognition of revenue from sham transactions. Defendants brought a motion to dismiss, and the court granted the motion. The court held that plaintiffs failed to plead falsity regarding defendants’ statements about the company’s financial results. Plaintiffs alleged that defendants made false statements regarding the company’s 2009 financial performance because the company improperly recognized and reported revenue from a sham sales transaction, but the court found that plaintiffs offered no specific facts to support this assertion. The court also held that plaintiffs failed to plead that the transaction was material, because it amounted to only 0.9 percent of the company’s 2009 revenue. The court rejected plaintiffs’ contention that intentional misconduct or an otherwise unlawful transaction transformed an immaterial transaction into a material one. The court also held that plaintiffs failed to allege that defendants’ statements regarding internal disclosure and controls were false, because a mere revision to financial statements does not, by itself, demonstrate fraud or falsity of statements regarding internal controls. The court also found that plaintiffs’ allegations failed to give rise to a strong inference of scienter. The court rejected plaintiffs’ assertion that defendants were motivated by a desire to increase the share price of a secondary offering, both because the secondary offering occurred before the disputed earnings were announced and because the complaint did not identify any concrete benefit flowing from the secondary offering to defendants. The size and nature of the company’s financial adjustments also could not create a strong inference of scienter. In addition, plaintiffs failed to identify the source of statements made in sales meetings and emails. Finally, the court held that plaintiffs failed to adequately plead loss causation because none of the disclosures cited by plaintiffs revealed the alleged fraud cited by plaintiffs as the basis of their claim.

c. Meridian Horizon Fund, L.P. v. KPMG (Cayman), Nos. 11-3311-cv, 11-3725-cv, 2012 WL 2754933 (2d Cir. July 10, 2012)

Plaintiffs, investors in certain hedge funds that fed into Bernard L. Madoff Investment Securities, LLC, brought claims against auditors of those funds, claiming they knowingly and recklessly issued false and misleading audit opinions in violation of Section 10(b) of the Exchange Act and Rule 10b-5. Specifically, plaintiffs alleged that the auditors ignored the “red flags” of Madoff’s fraud and conducted an inadequate audit of the feeder hedge funds. The district court dismissed, holding that plaintiffs failed to raise a strong inference of scienter.

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Plaintiffs appealed, and the Second Circuit affirmed the district court’s holding. The Second Circuit noted that in order for recklessness on the part of a non-fiduciary accountant to satisfy scienter, the recklessness must be conduct that is “highly unreasonable, representing an extreme departure from the standards of ordinary care” and that “approximate[s] an actual intent to aid in the fraud.” The court found that in this case, plaintiffs merely made allegations of “fraud by hindsight.” Defendants were responsible for auditing the feeder funds in which plaintiffs invested, not Madoff’s firm. The purported “red flags,” such as the lack of an independent third-party custodian and Madoff’s firm’s dual role as investment manager and administrator, were risks inherent to Madoff’s firm, not the feeder funds in which plaintiffs invested. In addition, these risks were disclosed not only to plaintiffs, but also to the SEC and investors in and auditors of other Madoff feeder funds, none of who discovered Madoff’s fraud. The more compelling inference, the court found, was that Madoff was proficient at covering up his scheme. The court also affirmed the dismissal of plaintiffs’ common law negligence and fiduciary duty claims.

d. Gould v. Winstar Communications, Inc., 692 F.3d 148 (2d Cir. 2012)

Plaintiff shareholders filed a putative class action against defendant corporation, its officers and directors, and its auditor, claiming violations of Sections 10(b) and 18 of the Exchange Act. As a result of settlements among the parties, the auditor was the only remaining defendant. Plaintiffs alleged that the auditor consciously ignored several “large account transactions” that the corporation consummated to conceal a decline in revenue and issued an unqualified opinion letter stating that the corporation’s Form 10-K complied with Generally Accepted Accounting Principles (GAAP) and fairly represented the corporation’s financial condition. The district court granted the auditor’s motion for summary judgment, finding that plaintiffs had failed to demonstrate that a genuine dispute of material fact existed as to whether the auditor acted intentionally or recklessly, as required under Section 10(b), and that a genuine dispute existed as to whether the shareholders relied on the auditor’s opinion letter, as required under Section 18. Plaintiffs appealed, and the Second Circuit vacated the district court’s decision and remanded the case for further proceedings. The court found that there were genuine issues of fact with respect to the scienter requirement because plaintiffs had proffered evidence showing that in the course of its audit, defendant auditor learned of the corporation’s deceptive accounting schemes and failed to confirm certain of the corporation’s representations, but nonetheless issued the unqualified opinion letter. The magnitude of defendant auditor’s work, in terms of time spent and documents reviewed, was not enough to immunize it from charges that it violated the securities laws. The court also found that plaintiffs satisfied the reliance element at this stage of the proceedings because they had proffered evidence showing that it was the general practice of the analyst who recommended the plaintiffs’ investment in the corporation to read the auditor’s letters before making a recommendation. Finally, the court found that although some of the drop in the corporation’s stock price may have been caused by broader market trends and the cancellation of the corporation’s credit facility, a jury could still reasonably find that part of the decline was substantially caused by the disclosures of the corporation’s fraud in the press.

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e. Lighthouse Financial Group v. Royal Bank of Scotland Group, PLC, No. 11-civ-398, 2012 WL 4616958 (S.D.N.Y. Sept. 28, 2012)

Plaintiffs, investors in defendant foreign bank’s American depository receipts (ADRs), brought a putative class action against the foreign bank and its current and former directors under Sections 11, 12(a)(2) and 15 of the Securities Act, Sections 10(b) and 20(a) of the Exchange Act, and Rule 10b-5. Plaintiffs claimed that the ADRs lost value due to defendants’ false and misleading statements and omissions regarding the bank’s acquisition of another foreign bank, the nature of its exposure to the US subprime mortgage market and other credit market assets, and its April 2008 rights offer. Defendants moved to dismiss, and the court granted their motion. The court dismissed the Exchange Act claims because neither the amount of due diligence performed by the bank in connection with its acquisition of another bank, nor conclusory allegations that the bank “knew” that its valuations of securitized assets were false — absent any facts showing that the bank disbelieved its valuations or that declines in broad market indicators had a direct effect on the bank’s assets — gave rise to a strong inference of scienter. The court dismissed plaintiffs’ Securities Act claims for failure to meet the pleading standards of both Rule 9(b) and Rule 8(a) because plaintiffs did not explain why the purported misstatements were false or misleading. Certain of defendants’ statements regarding the acquisition of the foreign bank were not literally false, while other statements relating to the bank’s subprime exposure were not actionable as misstatements or omissions or violations of International Financial Reporting Standards accounting standards because plaintiffs did not prove that the defendants’ valuations were both objectively false and disbelieved by defendants at the time. Finding no underlying violation of either the Exchange Act or the Securities Act, the court dismissed plaintiffs’ claims for control person liability. Finally, the court noted that plaintiffs’ complaint could also be dismissed solely on the grounds of plaintiffs’ failure to plead compliance with the one-year statute of limitations of the Securities Act, as well as the two-year statute of limitations of the Exchange Act.

3. Loss Causation

a. Solow v. Citigroup Inc., No. 10 Civ. 2927, 2012 WL 1813277 (S.D.N.Y. May 18, 2012)

Plaintiff, an individual investor, brought an action against defendants, financial corporation and its CEO, alleging violations of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5. In particular, the plaintiff investor alleged that the defendants made a series of material misrepresentations concerning the strength of the corporation’s financial position and liquidity throughout the fall of 2008. Defendants brought a motion to dismiss, and the court granted the motion, dismissing the complaint with prejudice.

The court held that the plaintiff investor failed to allege sufficient facts establishing that the defendants made material misstatements regarding the defendant financial corporation’s capitalization levels. The plaintiff alleged that the defendants made material misrepresentations when they asserted that the financial corporation had “a very strong Tier 1 ratio,” but the court found that the corporation was at all times a “well-capitalized” institution under the regulatory definition of the term and therefore the plaintiff investor failed to establish that the statements

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were false. The court also held that the defendants, who disclosed their exposure to the mortgage-related toxic assets, had no further obligation to disclose potential risks, noting that there is no duty to “speculate on future negative results or paint themselves in the most unflattering light possible.”

The court also held that the plaintiff investor failed to adequately plead loss causation. The plaintiff referred to a series of events, allegedly concealed by the defendants, that came to light revealing deficiencies in defendant financial corporation’s capital and liquidity and causing its stock to decline. The court found that none of the alleged events had an adequate link to the alleged misrepresentations about the corporation’s “well-capitalized” status. In its analysis, the court noted alternative explanations for the events and noted that there were intervening causes that superseded the direct effect of the defendants’ alleged misrepresentations, if any.

b. Acticon AG v. China North East Petroleum Holdings Limited, 692 F.3d 34 (2d Cir. 2012)

Plaintiff brought a putative class action against an issuer, its officers and directors, and an independent oil engineering firm alleging that defendants misled investors regarding the financial health and prospects of the company in violation of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5. Defendants moved to dismiss, arguing that plaintiff failed to allege economic loss because defendant’s share price rebounded on certain days after the final alleged corrective disclosure to the point that plaintiff could have sold its holdings and avoided a loss. The district court granted defendants’ motion to dismiss, finding plaintiffs had foregone multiple opportunities to sell its shares at a profit, and therefore did not suffer an economic loss under Dura. The Second Circuit vacated the judgment and remanded the case for further proceedings, finding that the price recovery did not defeat an inference of economic loss. The court considered the pleading standard necessary to adequately allege economic loss and determined that it was not necessary to resolve the issue in this case because the price fluctuations would not rebut an inference of economic loss under the Rule 8(a)(2) standard or the heightened Rule 9(b) standard. The court also found the district court’s holding — that a securities fraud plaintiff suffers no economic loss if the stock reaches a price that is higher than the plaintiff’s purchase price at some point after the final alleged corrective disclosure — was inconsistent with both the traditional out-of-pocket measure for damages and the “bounce back” cap imposed in the PSLRA. The court determined that it would be improper to offset gains that the plaintiff recovers after the fraud becomes known against losses caused by the revelation of the fraud if the stock recovers value for completely unrelated reasons. In the absence of fraud, plaintiff would have purchased the security at an uninflated price and would have also benefited from the unrelated gain in stock price. The court did not determine whether the price increases represented the market’s reactions to the disclosure of the alleged fraud or whether they represented unrelated gains, and thus it did not rule on the propriety of offsetting the price against the plaintiff’s losses in determining the plaintiff’s economic loss.

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4. Statute of Limitations

a. In re Merrill Lynch Auction Rate Securities Litigation, Nos. 09 MD 2030, 10 Civ. 0124, 2012 WL 1994707 (S.D.N.Y. June 4, 2012)

Plaintiff, an institutional investor, alleged violations of Section 12(a)(1) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 against a bank and broker-dealer for its alleged market manipulation and material misstatements and omissions in connection with plaintiff’s $100 million purchase from the defendant of certain auction rate securities (ARS). Defendant brought a motion to dismiss, and Southern District of New York granted the motion, dismissing the complaint with prejudice for failure to state a claim. The court found that plaintiff's Section 10(b), Rule 10b-5 and common law fraud claims failed because its ARS purchase was made in 2007, after the defendant had published adequate disclosures about its ARS practices and the risks involved on its website. The court also dismissed a claim alleging a violation of Section 12(a)(1) of the Securities Act, holding that the plaintiff failed to state a claim and that the claim would have been untimely under the statute of limitations and the statute of repose. Noting that Rule 144A provides a safe harbor from the registration requirements of the Securities Act for private re-sales to a “qualified institutional buyer” such as the plaintiff, the court dismissed the Section 12 claim as a matter of law. The court further held that the claim was time-barred under the statute of limitations because plaintiff failed to file suit within one year after the alleged violation occurred. The court rejected plaintiff’s contention that ARS were not susceptible to the statute of limitations because they were sold and resold, finding that after the initial sale the broker-dealer’s participation in the ARS market can only be characterized as a bidder or potential re-purchaser and thus is not subject to liability as a seller. The claim was also subject to the statute of repose because more than three years had passed since the security was bona fide offered to the public.

5. Standing/Extra-Territorial Application of the Securities Laws

a. Goldman Sachs v. NECA-IBEW Health & Welfare Fund, 693 F.3d 145 (2d Cir. 2012)

Defendant investment bank issued certificates representing interests in 17 separate trusts of mortgages. Plaintiff purchased certificates in two of those 17 trusts, and filed suit under Sections 11, 12(a)(2) and 15, alleging that the relevant offering documents contained material misrepresentations regarding underwriting guidelines, property appraisals for the loans backing the trusts and the risks associated with the certificates. Plaintiff also sought to assert claims on behalf of purchasers of certificates from the other 15 trusts on the grounds that claims relating to the other 15 trusts implicated the same set of concerns as plaintiff’s claims. The district court granted defendant’s motion to dismiss, and the Second Circuit granted in part, vacated in part and remanded for further proceedings. On the issue of plaintiff’s standing, the Second Circuit acknowledged that plaintiff “clearly lacks standing to assert” by itself claims regarding securities it never purchased, but nonetheless held that a plaintiff has class standing to assert the claims of purchasers of certificates in other trusts to the extent those certificates had characteristics similar to the ones plaintiff purchased and thus presented a sufficiently similar set of concerns. Using that standard, the court found that plaintiff had standing to assert claims on behalf of purchasers

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of certificates in five additional trusts even though plaintiff did not purchase certificates from those five trusts.

b. Absolute Activist Value Master Fund Ltd. v. Ficeto, No. 11-0221-cv, 2012 WL 661771 (2d Cir. Mar. 1, 2012)

Investors brought suit under Section 10(b) of the Exchange Act and Rule 10b-5 against officers of the investment management company retained by certain foreign hedge funds and the principals of a domestic broker-dealer based on allegations that defendants sold to investors securities that the defendants had fraudulently obtained. The Southern District of New York dismissed the complaint for lack of subject matter jurisdiction. On appeal, the Second Circuit affirmed in part, reversed in part, and remanded for further proceeding. Because petitioners did not argue the first prong of the Morrison test, the court first addressed the issue of what constitutes a “domestic transaction” under Morrison. The court held that a securities transaction is a “domestic transaction,” and thus subject to Section 10(b) and Rule 10b-5, when the parties incur irrevocable liability to carry out the transaction within the United States, or when title is passed within the United States. The court found that the complaint failed to state claims under Section 10(b) and Rule 10b-5 because it did not adequately allege the existence of domestic securities transactions. However, because the complaint was filed before Morrison was decided, the court directed the district court to grant petitioners leave to amend their complaint to plead additional factual allegations to support their claim that the securities transactions were “domestic transactions,” as defined by the Supreme Court in Morrison.

c. In re Optimal U.S. Litigation, No. 10 Civ. 4095, 2012 WL 1988713 (S.D.N.Y. June 4, 2012)

Plaintiffs, foreign persons and entities which invested in a foreign investment fund (the Fund) that in turn invested all collected assets with Bernard L. Madoff Investment Securities LLC, sued defendants, foreign financial conglomerates and investment companies, and a Fund employee for fraud under Section 10(b) of the Exchange Act, Rule 10b-5 and the common law. The Southern District of New York dismissed plaintiffs’ federal securities law claims after issuing an Order to Show Cause because plaintiffs failed to demonstrate that purchases of Fund shares abroad satisfied the standard for extraterritorial application of the Exchange Act under Morrison. The court held that plaintiffs’ reliance on the broad interpretation generally accorded to the phrase “in connection with” in Section 10(b) decisions ignores the presumption against extraterritorial application of the Exchange Act after Morrison. In light of the presumption against extraterritorial application of the Exchange Act and the attenuated relationship between the Fund and purported investments in domestic securities, the court held that investments in the Fund abroad were not sufficiently “in connection with” purchases of domestic securities to impose liability under the Exchange Act. Additionally, the court held that even if the “economic reality” test were viable, Morrison’s presumption against extraterritorial application of the Exchange Act, and the lack of a one-to-one relationship between Fund shares and referenced domestic securities present in prior cases where extraterritorial application of the Exchange Act was limited, did not warrant plaintiffs’ attempt to use the test to expand the Exchange Act’s reach.

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d. SEC v. Tourre, No. 10-civ-3229, 2012 WL 5838794 (S.D.N.Y. Nov. 19, 2012)

The SEC brought an action against a domestic investment bank and one of its employees under Section 10(b) of the Exchange Act, Rule 10b-5, and Section 17(a) of the Securities Act of 1933 . Specifically, the SEC alleged that defendants made misrepresentations relating to collateralized debt obligation (CDO) notes that were structured and marketed by defendant investment bank. When the relevant CDO deal closed in New York, defendant domestic investment bank acquired title to the CDO notes from the trustee and transferred the notes to its Euroclear account. The notes were subsequently transferred to another branch of defendant domestic investment bank’s Euroclear account, and then finally to the foreign purchasing company’s Euroclear account. It was undisputed that the foreign purchasing company never acquired irrevocable liability to take and pay for the notes in the US, and the domestic investment bank was dismissed from the action pursuant to a consent decree. Defendant employee moved for dismissal. The court applied Morrison and dismissed the Section 10(b) and Rule 10b-5 claims as to the employee, finding that the note purchases by the foreign commercial bank and the foreign purchasing company were not domestic transactions. The SEC moved for partial relief from the court’s order pursuant to Rule 54(b) following the Second Circuit’s decision in Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60 (2d Cir. 2012), which established that a transaction’s domestic transfer of title is sufficient to survive a motion to dismiss under Morrison. The court denied the SEC’s motion for partial relief, finding that the domestic transfer of title from the CDO trustee to defendant domestic investment bank at the New York-based closing did not meet Section 10(b)’s requirement that the alleged fraud be “in connection with” an offending domestic transaction. The court held that for Section 10(b) and Rule 10b-5 to apply, the domestic securities transaction must be the alleged fraudulent transaction. Because the only domestic transaction was the US-based transfer of title between two parties, neither of whom was the party upon which the alleged fraud was perpetrated, there was no fraudulent US-based transfer of title “in connection with” the foreign note purchase sufficient to sustain the Section 10(b) and Rule 10b-5 claims.

6. Item 303 Disclosure Obligations

a. Panther Partners Inc. v. Ikanos Communications, Inc., No. 11-63-cv, 2012 WL 1889622 (2d Cir. May 25, 2012)

Plaintiff investor alleged that defendant issuer, its officers and its underwriters violated Sections 11, 12(a)(2), and 15 of the Securities Act by failing to disclose defects in the issuer’s semiconductor chips allegedly known to the issuer before the issuer’s secondary securities offering. Specifically, plaintiff alleged that defendants failed to disclose the magnitude of the defect in either the registration statement or prospectus, even though months after the second offering, the defendant issuer had (i) determined that the chips had an “extremely high” failure rate, (ii) recalled the chips sold to its two largest customers and (iii) reported a $2.2 million loss. The district court denied plaintiff’s motion to file a proposed amended complaint, finding that the complaint failed to allege that the issuer knew the defect rate was above average before filing the registration statement. The Second Circuit held that Item 303 disclosure obligations “do not turn on restrictive mechanical or quantitative inquiries” and vacated the judgment of the Southern District of New York, remanding the case with instructions to permit the filing of the

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amended complaint. The Second Circuit stressed that for the purposes of the defendant’s disclosure obligations under Item 303 of Regulation S-K, the defect rate, in and of itself, was not the relevant issue. Instead, the issue was whether the uncertainty surrounding the defect rate might reasonably be expected to have a material impact on future revenues. The court concluded that plaintiff plausibly alleged that the defect and its potential impact on the issuer’s business constituted an uncertainty that the defendants reasonably expected would have a material unfavorable impact on revenues. The fact that there were no recalls of the chips and no determination of the chips’ exact failure rate until after the secondary securities offering did not undermine the plausible inference that the issuer was aware of the uncertainty that it might have to replace and recall a “substantial volume” of defective chips. Finally, the Second Circuit concluded that the investor adequately alleged that the defendants’ “generic cautionary” disclosure that complex products produced by the issuer frequently contain defects was insufficient to comply with Item 303.

7. Class Action Certification

a. New Jersey Carpenters Health Fund v. RALI Series 2006-QO1, No. 11-cv-1683, 2012 WL 1481519 (2d Cir. Apr. 30, 2012)

Investors who purchased MBS that lost substantial value in the months after they were issued brought class action suits against defendant issuers and underwriters under Sections 11, 12, and 15 of the Securities Act, alleging that defendants made false and misleading statements in the prospectuses for the various MBS. The district court denied plaintiffs’ motion for class certification under Rule 23(b)(3), and the Second Circuit affirmed. The court held that the district court properly exercised its discretion in determining that individual issues predominated over common issues, particularly because affirmative defenses based on investors’ knowledge of defendants’ misstatements at the time of purchase would have required many individualized inquiries. The court rejected plaintiffs’ argument that the district court erred by analyzing the class’s cohesiveness under superiority rather than predominance, stating that there is no independent requirement of cohesiveness.

8. Class Action Fairness Act

a. BlackRock Financial Management Inc. v. The Segregated Account of Ambac Assurance Corp., No. 11-507-cv(L), 2012 WL 611401 (2d Cir. Feb. 27, 2012)

Petitioner trustee to certain trusts containing MBS had initiated a proceeding in state court to authorize its entering into a settlement agreement with petitioner institutional investors in the trusts, who had complained that the originator and servicer of the mortgages had breached their duties under the Pooling and Servicing Agreements (PSAs). Respondents, also investors in some of the trusts, intervened in the state proceeding in order to exclude those trusts from the settlement and removed the proceeding to the federal district court pursuant to the Class Action Fairness Act’s (CAFA’s) expanded federal jurisdiction for “mass actions.” Petitioners moved to remand, arguing that the trustee’s claims fell under CAFA’s exception for claims relating to certain securities. The district court denied the motion, but the Second Circuit reversed the order. The Second Circuit reversed, finding that there was no federal jurisdiction pursuant to the

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securities exception to CAFA. The court noted that CAFA’s securities exception bars claims based on “the terms of the instruments that create and define securities or on the duties imposed on persons who administer securities,” as opposed to claims based on rights arising from independent sources of state law. Because the trustee sought judicial construction of the PSAs and an instruction that its actions complied with its obligations under the PSAs and the law of trusts, its claims fell under the securities exception.

9. Short Swing Profits

a. Roth ex rel. Leap Wireless International, Inc. v. Goldman Sachs Group, Inc., No. 11 Civ. 4820, 2012 WL 2006021 (S.D.N.Y. June. 5, 2012)

An investor in a nationwide cellular service provider brought a derivative action on behalf of the nationwide cellular service provider against defendant investment bank and defendant cellular service provider as nominal defendant, alleging that defendant investment bank violated Section 16(b) of the Exchange Act by profiting from the sale and expiration of short call options written while the investment bank owned more than 10 percent of the cellular provider’s common stock. Defendants brought a motion to dismiss and the court granted the motion in its entirety. The court held that the writing of short-call options qualifies as a purchase or sale of securities under Section 16(b). The court further held that if such a purchase or sale could be matched with another purchase or sale within a six-month period when the writer of the option also held 10 percent or more of qualifying securities, liability could attach pursuant to Section 16(b), requiring the disgorgement of any “short swing profits.” The court rejected plaintiff’s argument that merely writing options while holding 10 percent or more of a qualifying security made defendants liable under Rule 16b-6(d), holding that both the writing of the option and the expiration of the option must occur during the six-month period required under Section 16(b) for liability to attach. Here, although the defendant investment bank wrote the short-call options while holding in excess of 10 percent of the cellular provider’s common stock, and thus was a statutory insider, liability under Section 16(b) could not attach because the options expired after defendant investment bank’s disposal of a sufficient amount of the stock to bring its holdings below 10 percent. Because only one qualifying purchase or sale occurred during the time the defendant investment bank was a statutory insider, there could be no Section 16 violation.

10. Substantial Assistance

a. SEC v. Apuzzo, 689 F.3d 204 (2d Cir. 2012)

The SEC brought an action under Section 20(e) of the Exchange Act against the CFO of an equipment manufacturing company, alleging that he aided and abetted securities law violations by assisting in two fraudulent “sale-leaseback” transactions designed to allow a separate equipment rental company to prematurely recognize revenue and to inflate profits in violation of GAAP. The district court granted defendant’s motion to dismiss, finding that the complaint did not meet the “substantial assistance” component of aiding and abetting liability because it failed to adequately allege that defendant was the proximate cause of the sale-leaseback scheme, the harm on which the primary violation was predicated. The SEC appealed

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the district court’s dismissal, and the Second Circuit reversed and remanded for further proceedings. The Second Circuit held that the district court had erred in concluding that proximate causation was required to show substantial assistance. Instead, the court held that to satisfy the substantial assistance component of Section 20(a) the SEC must show that the defendant “in some sort associate[d] himself with the venture, that [the defendant] participate[d] in it as in something that he wishe[d] to bring about, [and] that he [sought] by his action to make it succeed.” Using this standard, the court held that the complaint plausibly alleged that defendant had provided substantial assistance in carrying out the fraudulent transactions because it alleged that he negotiated and participated in the transactions, and approved and signed agreements that he knew were designed to conceal details about the transactions. The court also held that where the complaint alleges that the defendant possessed a high degree of actual knowledge of the primary violation, the burden to allege substantial assistance is lessened. Here, because the complaint alleged a high degree of knowledge of the fraud on defendant’s part, the allegations of substantial assistance could not be viewed, as defendant argued, as “business as usual,” but rather must be viewed as an effort to purposely assist the fraud and to help make it succeed.

11. Dodd-Frank/Whistleblower Protection

a. Ott v. Fred Alger Management, Inc., No. 11-cv-4418, 2012 WL 4767200 (S.D.N.Y. Sept. 12, 2012)

A portfolio manager at an investment management firm brought suit against her employer, two of its officers and two related companies under the anti-retaliation provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), 15 U.S.C. § 78u-6(h)(1)(a), as well as numerous state laws. Plaintiff alleged that she provided information to the SEC about her employer’s unlawful trading both before and after July 22, 2010, the effective date of the Dodd-Frank Act. Plaintiff further alleged that after she spoke with the SEC, she was harassed, given a bonus that was 92 percent less than she received the previous year, demoted and ultimately fired. Defendants moved to dismiss, and the court denied the motion with respect to the Dodd-Frank Act claim and granted the motion as to all other claims. The court rejected defendants’ argument that plaintiff’s reports to the SEC did not constitute engagement in a protected activity, which is required under the Dodd-Frank Act’s anti-retaliation provision, because her initial report was made before the effective date of that act. First, the court noted that the language of the anti-retaliation provision does not require an individual to provide “original information,” only “information.” To the extent that defendants relied on an SEC comment requiring that plaintiffs provide “new” information, this comment was made in the context of a provision determining when a whistleblower is entitled to an award. Anti-retaliation protections apply, however, whether or not a plaintiff is entitled to an award. Second, the court noted that it could fairly infer that plaintiff supplied the SEC with “new” information through a complaint she filed after the Dodd-Frank Act’s effective date. In addition, the court stated that there is at least some authority to support the proposition that even if plaintiff’s entire report to the SEC had occurred before the effective date of the act, she would still be protected because the adverse actions occurred after the Act’s effective date.

The court also rejected defendants’ argument that plaintiff did not engage in a protected activity because she did not have a reasonable belief that the trading policy violated securities

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law. The SEC has defined a reasonable belief as a belief that is both subjectively genuine and objectively reasonable. The court found plaintiff’s belief that the trading policy was unlawful to be both subjectively genuine, despite her adherence to it for two months without action, and objectively reasonable because another employee referred to the policy as “sabotage” and the SEC referred the matter for a formal investigation. The court held that plaintiff adequately pled an adverse employment action because she alleged that her bonus was cut and she was ultimately fired.

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IV. FIFTH CIRCUIT

A. NOTEWORTHY CASES IN 2012

1. Pleading Standards for Securities Fraud

a. In re BP P.L.C. Securities Litigation, No. 10-md-2185, 2012 WL 468519 (S.D. Tex. Feb. 13, 2012)

Plaintiff investors brought claims under Section 10(b) against defendant oil company, alleging that the company and several of its officers issued false statements regarding safety and risk management after the Deepwater Oil Rig explosion in the Gulf of Mexico caused the company’s stock price to plummet. The court dismissed the complaint, finding plaintiffs failed to present allegations of fact sufficient to support their claims that several of the statements regarding safety measures were false or misleading. In this regard, the court found that plaintiffs’ allegations were far too vague to satisfy the requirement that plaintiffs identify material misstatements of fact. The court further held that plaintiffs’ allegations failed to satisfy the scienter requirement because (i) plaintiffs failed to identify specific authors, documents and recipients of various reports of which the individual defendants allegedly had knowledge and (ii) three of the alleged misstatements merely were mistakes in a series of public filings separated by long periods of time, suggesting that the mistakes likely were attributable to careless management mistakes, not fraud.

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V. SIXTH CIRCUIT


The Sixth Circuit and the district courts in Kentucky and Ohio issued several notable decisions in 2012. In Nolfi v. Ohio Kentucky Oil Corp., the Sixth Circuit applied the Supreme Court’s recent decision in Merck & Co., Inc. v. Reynolds to uphold a jury verdict in favor of plaintiffs under Section 10(b) of the Exchange Act, finding that plaintiffs’ claims were not time-barred because the statute of limitations did not begin running prior to the point at which they could have discovered defendants’ intent to deceive using reasonable diligence. In In re National Century Financial Enterprises, Inc., the Southern District of Ohio largely denied defendants’ motion for summary judgment. Here, the court concluded that plaintiff offered sufficient evidence to support a finding that an initial purchaser and placement agent of notes had made the alleged misrepresentations. And in In re Almost Family, Inc. Securities Litigation, the Western District of Kentucky affirmed dismissal of a lawsuit brought against a corporation and two of its officers for alleged violations of the Exchange Act because plaintiffs failed to adequately allege that defendants made false factual representations and that they knowingly made false statements of opinion.



a. In re National Century Financial Enterprises, Inc., 846 F. Supp. 2d 828 (S.D. Ohio 2012)

Plaintiffs, institutional investors who purchased notes from a privately-held finance company, filed suit against the initial purchaser and placement agent of the notes, alleging fraud, negligent misrepresentation, aiding and abetting fraud, and violations of Section 10(b) of the Exchange Act. Specifically, plaintiffs alleged that the finance company sold the notes despite knowing that the issuer was fraudulently reporting “purchases” of worthless or non-existent receivables from healthcare companies in which the issuer’s executives held undisclosed ownership interests. The court largely denied defendants’ motion for summary judgment. The court found that plaintiffs provided sufficient evidence to support a finding that defendants made or had control over the alleged misrepresentations. The court noted that defendants had input into the contents of the private placement memoranda and communicated them to the investors, made specific representations during road show presentations, prepared various reports that were distributed to investors and engaged in numerous phone and email communications during which they made alleged misstatements. The court rejected defendants’ claim that all of the allegedly actionable statements made in the road show presentations were mere puffery. The court also rejected defendants’ argument that the reports contained non-actionable opinions, finding that the statements transcended opinions or beliefs and were, in fact, specific factual representations.

In terms of the remaining elements of plaintiffs’ Section 10(b) claim, the court found that even if defendants were not fully aware of how the company’s scheme was operating, they knew or should have known that it was fraudulent. Moreover, the court held that despite being sophisticated parties, plaintiffs were justified in relying on defendants’ representations and that

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their losses were attributable to defendants’ alleged misstatements and omissions. The court dismissed plaintiffs’ “holder” claims — which sought to hold defendants liable for inducing them to hold their notes at times when they could have sold them — primarily because plaintiffs lacked evidence of an intent to sell their notes, and likewise dismissed plaintiffs’ claims of negligent misrepresentation because there was no evidence that a special relationship existed between plaintiffs and defendants.

b. Louisiana Municipal Police Employees Retirement System v. Cooper Industries PLC, No. 12-CV-1750, 2012 WL 4958561 (N.D. Ohio Oct. 16, 2012)

Plaintiffs, shareholders of the target company in a merger, brought claims against the company, various directors of the company, and the potential acquiror, alleging that defendants violated Sections 14(a) and 20(a) of the Exchange Act in connection with the proposed sale of the company. Plaintiffs alleged that the proxy statement accompanying the merger contained various misstatements and material omissions relating to allegedly unfair sales practices associated with the potential merger as well as financial projections of the newly formed entity. The individual defendants and the potential acquiror moved to dismiss arguing that plaintiffs failed to allege any material misstatement or that defendants omitted material information from the proxy statement. The District Court for the Northern District of Ohio granted defendants’ motion, holding that plaintiffs failed to adequately plead a material misstatement or omission. For an omission of information in a proxy statement to be actionable under Section 14(a), SEC regulations must specifically require the disclosure of such information, or, alternatively, the omission must make other statements in the proxy statement materially false or misleading. The court held that plaintiffs failed to identify either an SEC Rule requiring the disclosure of the allegedly omitted information or a statement that became materially misleading as a result of an omitted fact. The court also granted defendants’ motion to dismiss with respect to plaintiffs’ Section 20(a) claim. To succeed on a Section 20(a) claim, plaintiffs must establish a primary violation of federal securities laws. Because plaintiffs failed to establish its Section 14(a) claim, there was no actionable primary violation to base a Section 20(a) claim on.

2. Materiality

a. In re Almost Family, Inc. Securities Litigation, No. 3:10-CV-00520-H, 2012 WL 443461 (W.D. Ky. Feb. 10, 2012)

Plaintiffs brought suit against defendant in-home healthcare corporation and two of its officers for making material misstatements in violation of Sections 10(b) and 20(a) of the Exchange Act. Plaintiffs alleged that defendants allegedly made a number of misstatements both orally and in financial statements regarding the corporation’s compliance with Medicare regulations when the company was, in fact, manipulating the number of therapy visits provided to patients in order to increase Medicare payments. Defendants moved to dismiss the action for failure to state a claim, arguing that plaintiffs failed to sufficiently plead materiality and loss causation. With respect to materiality, the court emphasized a distinction between “hard” facts (objectively verifiable information), and “soft” facts (predictions and matters of opinion). The plaintiff has the burden of establishing that the hard fact or information provided by the defendant was false. Alternatively, predictions and matters of opinions are only actionable where

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a plaintiff pleads that the defendant had actual knowledge that the “soft information” disclosed was false. Actual knowledge that a disclosed opinion or prediction was false triggers a duty to disclose. In such an instance, the plaintiff must (i) establish defendant’s actual knowledge of the “soft” fact’s falsity and (ii) plead with particularity each alleged misstatement and claim of fraud. In this case, plaintiffs failed to allege that defendants made material misrepresentations because they failed to allege that the “hard” facts contained in the corporation’s financial statements were substantially inaccurate. Further, the individual defendants’ certifications that the reports contained no untrue statements constituted “soft” opinions that were insufficient to establish a material misrepresentation absent a pleading that defendants knew the representation to be inaccurate. The court also found that confidential witness statements seeking to show defendants’ knowledge of the falsity of their statements regarding compliance with Medicare regulations made only vague references to a limited number of potentially fraudulent incidents and were therefore insufficient to impute actual knowledge to the defendants.

b. Filing v. Phipps, No. 11-4157, 2012 WL 5200375 (6th Cir. Oct. 23, 2012)

Plaintiff asserted claims under Section 10(b) of the Exchange Act and Rule 10b-5 against defendants, four officers of the closed corporation where plaintiff was employed (the Company), alleging that defendants failed to disclose discussions about the potential acquisition of the Company before plaintiff sold shares of the Company’s stock. The District Court for the Northern District of Ohio granted defendants’ motion for summary judgment and the Sixth Circuit affirmed. In February 2004, plaintiff sold almost half of his Company stock to the Company and defendant CEO. Meanwhile, in October 2003, one of the Company’s competitors contacted defendant CEO expressing an interest in acquiring the Company. The two companies executed a confidentiality agreement and the potential acquiror made a conditional offer to purchase the Company, however, negotiations eventually stalled. Two years later, negotiations resumed and the competitor acquired the Company for $22 million. After the acquisition, plaintiff filed suit against defendants because, had he known about the negotiations, he would not have sold his Company stock until after the acquisition, which would have increased his profit.

The district court held that plaintiff failed to establish the materiality element required to succeed on a Section 10(b) claim and the Sixth Circuit affirmed. Relying on the Supreme Court’s decision in Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988), the Sixth Circuit stated that a fact is material “if a substantial likelihood exists that a reasonable shareholder would (1) consider the fact important in making an investment decision and (2) view the fact as having significantly altered the total mix of information available.” While acknowledging that the acquisition of a company is often one of the most important events of a closed corporation’s existence, the Sixth Circuit noted that not every discussion creates a legal obligation. The materiality of acquisition discussions turns on the probability that the event will occur weighed against the anticipated magnitude of the event in light of the totality of the company activity. To determine whether negotiations are material, courts look at factors such as board resolutions, instructions to investment bankers and/or attorneys to facilitate the acquisition, actual negotiations between principals, the exchange of confidential information between companies and the preparation of negotiation reports. Regarding discussions at issue in this case, executives from each company participated in a few preliminary discussions before plaintiff sold his stock. Those negotiations never reached the level of finalizing a deal structure or price. Further, the Company never hired

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investment bankers or attorneys to facilitate the acquisition, nor did the Board of Directors pass any resolutions in connection with the potential acquisition. The Sixth Circuit, therefore, affirmed the district court’s decision granting defendants’ motion for summary judgment, finding that the acquisition discussions were not material and did not invoke a disclosure obligation.

3. Statute of Limitations

a. Nolfi v. Ohio Kentucky Oil Corp., 675 F.3d 538 (6th Cir. 2012)

Plaintiffs brought this action on behalf of a deceased investor, alleging that an oil company and its officers engaged in fraud and made misrepresentations in connection with the sale of oil and gas related securities. In December 2004, after investigating why the decedent, who, at the time, was showing signs of dementia, invested and lost large sums of money in defendants’ limited partnerships and joint ventures, plaintiffs filed a state court action alleging common law fraud and other claims. During discovery in that case, plaintiffs learned facts giving rise to federal securities claims. In 2006, plaintiffs subsequently filed suit in federal court against defendants alleging violations of Section 10(b) of the Exchange Act and Section 12(a)(1) of the Securities Act. The district court dismissed the Section 12(a)(1) claims as time-barred, but plaintiffs prevailed on their Section 10(b) claims in a jury trial.

Defendants appealed, arguing, inter alia, that plaintiffs’ Section 10(b) claims were barred by the two-year statute of limitations under 28 U.S.C. Section 1658(b). Defendants claimed that plaintiffs were on inquiry notice and had a “duty to investigate” any Section 10(b) violation in February 2002, when they learned that most of the oil wells drilled with the investor’s money were completely dry. Yet, plaintiffs did not file Section 10(b) claims until 2006, four years after the limitations period had allegedly expired. Plaintiffs countered that they could not have learned of defendants’ fraudulent intent until they obtained discovery in the state court action. There, plaintiffs learned that defendants had solicited investments on one-sided terms, whereby they would keep any investments even if no oil was found. This encouraged defendants to avoid drilling in areas likely to strike oil.

The Sixth Circuit rejected defendants’ argument that a plaintiff’s “duty to investigate” suspicious circumstances triggers the two-year statute of limitations for a Section 10(b) claim. Following the Supreme Court’s analysis in Merck & Co., Inc. v. Reynolds, the Sixth Circuit held that the two-year statute begins to run when a “reasonably diligent plaintiff would have discovered facts constituting the violation” — including a defendant’s “intent to deceive” — and not earlier. In this case, it was only through discovery in the state court case that plaintiffs could have learned of defendants’ intent to deceive, bringing the filing of their federal suit within the two-year statute of limitations.

4. SLUSA

a. Daniels v. Morgan Asset Management, Inc., No. 10-6335, 2012 WL 3799150 (6th Cir. Aug. 31, 2012)

A corporate trustee of certain investor accounts entered into written contracts with an investment services firm for the provision of investment advice with respect to its clients’ custodial accounts. These custodial accounts invested heavily in a series of mutual funds that

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were owned by the corporate trustee. When these mutual funds suffered substantial losses, investors brought a class action in state court against the investment services firm, the corporate trustee and related defendants, alleging breach of contract and negligence. Plaintiffs alleged both that the investment services firm was negligent in its advice, and that that the corporate trustee and investment services firm had a certain shared corporate structure that created a conflict of interest. Defendants filed a motion to dismiss arguing that these claims were precluded under the Securities Litigation Uniform Standards Act (SLUSA), which was enacted to restrict plaintiffs from circumventing the stricter federal standards by bringing state law class actions based on allegations of untruth or manipulation in connection with the purchase or sale of a covered security. In affirming the dismissal of plaintiffs’ action, the Sixth Circuit held that SLUSA precluded their state class action claims for breach of contract and negligence because they were based on allegations of an omission of material fact — namely, an undisclosed conflict of interest that required the investment services firm to invest assets of the custodial accounts in the mutual funds owned by the corporate trustee. In explaining its decision, the Sixth Circuit emphasized that any state claim based on allegations of an untrue statement or misstatement is precluded, not just claims in which that untrue statement or misstatement is a material element.

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VI. SEVENTH CIRCUIT


During 2012, the courts in the Seventh Circuit issued several noteworthy decisions interpreting pleading requirements for securities fraud. In Fulton County Employees Retirement System v. MGIC Investment Corporation, the Seventh Circuit affirmed the dismissal of a securities class action, holding plaintiff failed to plead falsity and scienter as to statements regarding defendant’s ability to meet margin calls based on the defendant’s historical ability to meet margin calls in periods of similar liquidity. In Plumbers & Pipefitters Local Union 719 Pension Fund v. Zimmer Holdings, the Seventh Circuit held plaintiff failed to plead scienter where defendant’s omission of certain facts in an answer to a question was merely “evasive,” which the court deemed “short of fraudulent.” In Ross v. Career Education Corp., the Northern District of Illinois denied most of the defendants’ motion to dismiss, finding that the complaint alleged sufficient facts regarding key confidential witnesses — including the witnesses’ titles, periods and locations of employment with the issuer, and the information each witness provided — to satisfy the PSLRA.



a. Fulton County Employees Retirement System v. MGIC Investment Corporation, 675 F.3d 1047 (7th Cir. 2012)

Plaintiff shareholders brought this class action against defendant issuer for violations of Sections 10(b) and 20(a) of the Exchange Act. The district court dismissed plaintiffs’ complaint for failing to meet the pleading requirements of the PSLRA. One of the plaintiffs appealed the dismissal of its claim that the issuer and executives of an entity in which the issuer invested made false statements in connection with a quarterly earnings call. The Seventh Circuit affirmed the dismissal, holding that plaintiff failed to plead falsity as to the issuer’s statement in a press release that the investment entity maintained “substantial liquidity to cover margin calls in the event of substantial declines in the value of its mortgages and securities,” because (i) the entity’s cash reserves were substantial and (ii) the entity had historically been able to meet margin calls. The court also held the plaintiff did not adequately allege scienter because the entity had previously been able to pay its margin calls and maintain significant cash reserves, which indicated that there was no bad intent on the part of the managers in asserting the entity had substantial liquidity. Additionally, the court noted that, particularly given the subprime mortgage market at the time, the issuer provided sufficient cautionary language following its substantial liquidity statement, and was not required to foresee or disclose the ultimate huge decline the subprime mortgage market. Next, the court rejected plaintiff’s Section 20(a) control person theory predicated on statements made by executives of the investment entity during the earnings call, because the issuer’s 46 percent ownership share (where others owned 46 percent and 8 percent) was not sufficient for the issuer to exercise unilateral control over the investment entity. Finally, the court rejected the argument that the investment entity executives’ statements constituted the statements of the issuer.

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b. Brasher v. Broadwind Energy, Inc., No. 11 CV 991, 2012 WL 1357699 (N.D. Ill Apr. 19, 2012)

Plaintiff shareholders brought this class action against defendant issuer, individual defendants (including current and former officers of the issuer) and entities effectively constituting the issuer’s controlling shareholder. Plaintiffs alleged violations of Sections 10(b) and 20(a) of the Exchange Act, asserting two theories of liability: (1) that defendants made misleading statements in public filings about the issuer’s financial condition during 2009 and 2010, including statements made in a January 2010 prospectus in connection with the issuer’s public offering, despite knowing about significant troubles experienced by the issuer’s subsidiary and (2) that defendants overstated and fraudulently delayed impairment testing of the issuer’s goodwill and intangible assets.

The court granted defendants’ motion to dismiss in part. The court first found that plaintiffs did not allege that the individual defendants (except for the issuer’s CEO) acted with scienter, given that most of them were alleged to have only signed purportedly false issuer-published documents. Next, the court dismissed the claims against the controller shareholder defendants because plaintiffs did not show how they could have controlled the actions of the issuer. The court next held that plaintiffs failed to show that defendants made misleading statements or omissions regarding the subsidiary’s financial condition in its public filings because defendants had in fact disclosed much of the detailed information about the subsidiary’s dire financial circumstances that plaintiffs alleged was absent from public filings. However, the court denied defendants’ motion to dismiss claims related to the impairment of goodwill and intangible assets because the complaint adequately alleged that defendants’ improperly delayed the disclosure of information regarding that testing.

c. Boca Raton Firefighters & Police Pension Fund v. DeVry, Inc., No. 10 C 7031, 2012 WL 1030474 (N.D. Ill. Mar. 27, 2012)

Plaintiff investor alleged defendant issuer violated Exchange Act Section 10(b) based in large part on statements from 33 confidential witnesses (CWs). The court held plaintiff failed to adequately plead materiality, scienter, and loss causation. First, the court criticized plaintiff’s reliance on the 33 CWs, deeming the allegations vague and insufficient to indicate company-wide knowledge. The court held plaintiff failed to plead materiality because plaintiff’s allegation that defendant had a “sales-driven corporate culture” would not have surprised investors. The court also held plaintiff did not sufficiently plead the fraud-on-the-market theory of loss causation both because the alleged “corrective disclosures” (i) did not reveal the fraud alleged in the complaint and (ii) disclosed information about defendant’s industry generally, and not specifically about defendant.

d. Ross v. Career Education Corp., Case No 12 C 276, 2012 WL 5363431 (N.D. Ill. Oct. 30, 2012)

Plaintiff shareholders filed a putative class action against issuer company that owns for-profit colleges and professional schools, its CEO and its CFO. The complaint asserted claims under Sections 10(b) and 20(a) and Rule 10b-5 based on allegations that defendants made materially false and misleading statements regarding the company’s job placement rate for

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graduates and its regulatory compliance. Defendants moved to dismiss all claims. The court granted defendants’ motion to dismiss the claims against the CFO but otherwise denied defendants’ motion. The court held that, viewing the complaint as a whole, it alleged that the company made materially false statements during the class period when it asserted that prior legal and compliance-related problems were behind it. The court reasoned that such statements suggested that the issuer had abandoned formerly problematic job placement reporting practices and was in compliance with applicable regulations. The court further held that the complaint adequately alleged scienter, because various confidential witness statements indicated that high-level company employees knew of the problematic job placement reporting practices. With respect to the company’s CEO, the court held that he had purportedly been hired to ensure the issuer’s compliance with applicable standards related to its job placement rate for graduates. It was thus reasonable to infer that he looked into that issue and was aware of any deficiencies that persisted. The court held, however, that the complaint failed to allege scienter with respect to the CFO because the only allegations about him were that he knew material aspects of the company’s operations and approved the company’s SEC filings. Finally, the court held that the complaint adequately alleged loss causation for the entire class period because, while several of the disclosures on which plaintiffs relied related only to alleged misrepresentations from the last two years of the class period, one disclosure related directly to alleged misrepresentations regarding job placement rate reporting and was not limited to any specific time period.

2. Scienter

a. Plumbers & Pipefitters Local Union 719 Pension Fund v. Zimmer Holdings, 679 F.3d 952 (7th Cir. 2012)

Plaintiff investor sought to represent a putative class of investors in a suit alleging that defendants, an issuer and certain of its officers, violated Sections 10(b) and 20(a) of the Exchange Act by failing to disclose (1) high failure rates of one of its products and (2) quality-control and revenue issues at one of its plants. The Seventh Circuit affirmed the district court’s dismissal of plaintiff’s complaint because plaintiffs failed to plead scienter with particularity. Defendants argued that the product’s high failure rate was not due to a product defect, but rather to improper use of the product. The court rejected the notion that defendants’ explanation was knowingly false because (i) the explanation was plausible and (ii) plaintiff could not demonstrate the predicate for its argument — that the product was flawed. The court also rejected plaintiff’s scienter allegations based on an alleged misrepresentation by one of the issuer’s managers. Faced with the question of whether the issuer had received any warning letters or “483s” — a type of regulatory “information warning” — the manager answered only that the issuer had not received any warning letters, but did not address whether the issuer had received any 483s. The issuer had, in fact, received 483s. The court held the manager’s answer was “evasive” but “short of fraudulent.”

b. Wade v. WellPoint, Inc., Case No. 08-cv-00357, 2012 WL 3779201 (S.D. Ind. Aug. 31, 2012)

Plaintiff investor filed a putative class action under Sections 10(b) and 20(a) and Rule 10b-5 alleging that defendants — an issuer and certain of its officers — made material misrepresentations and omissions regarding defendant issuer’s projected profitability. The

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allegations centered primarily around an alleged scheme through which health care insurers intentionally underreported their costs. Plaintiff alleged that insurers and the third-party company that maintained the universal database of medical procedure reimbursement rates conspired to set “standard” reimbursement rates lower than actual market rates, thereby underpaying those insured on their claims and underreporting the insurers’ costs of coverage. Plaintiff alleged that this scheme allowed the defendants to knowingly overstate their financial projections. The court held the complaint failed to plead facts sufficient to support a finding of scienter. The court was persuaded by the fact that many managers with knowledge of the alleged scheme did not sell their stock to improperly profit from it. The court dismissed the complaint without prejudice due to insufficient allegations of scienter and the PSLRA’s safe harbor. The court also found that the plaintiff failed to adequately plead loss causation, citing both the “litany of Company woes” unrelated to the alleged misrepresentations, and the fact that the plaintiff did not even allege that the public announcement of the alleged scheme caused a decline in the company’s stock price.

3. SLUSA

a. Jorling v. Anthem, 836 F. Supp. 2d 821 (S.D. Ind. 2011)

Former members of defendant mutual insurance company, which demutualized into a stock corporation, brought several state law claims alleging that they had been inadequately compensated for their ownership interests in defendant as part of the demutualization. Plaintiffs alleged that defendant improperly distributed the interests and entitlements to demutualization compensation, diluting the value of plaintiffs’ shares by issuing three million more shares than had been disclosed to defendant’s members. Defendant argued plaintiffs’ claims were precluded under SLUSA and the court agreed, holding that SLUSA preclusion applied because the “substantive concepts inherent in the complaint” included allegations that defendant failed to disclose key information in connection with its initial public offering.

b. Appert v. Morgan Stanley Dean Witter, Inc., 673 F.3d 609 (7th Cir. 2012)

Plaintiff investor filed a complaint in state court for breach of contract and unjust enrichment against issuer defendant for charging plaintiff a handling, postage and insurance (HPI) fee without disclosing the actual costs incurred and charging a fee that was grossly disproportionate to the actual costs. Defendant removed the action to federal court, in part arguing in part that the SLUSA preempted the claim. The district court granted defendant’s motion, and plaintiff appealed. The Seventh Circuit held plaintiff’s state claims were not precluded under SLUSA because plaintiff did not allege a misstatement or omission of a material fact. The court relied on a Second Circuit case that held an alleged misrepresentation or omission regarding HPI fees was not material to an investor’s decision to buy or sell a security under Section 10(b). The Seventh Circuit adopted the Second Circuit’s reasoning that “no reasonable investor would have considered it important, in deciding whether or not to buy or sell stock, that a transaction fee of a few dollars might exceed the broker’s actual handling charges.”

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VII. NINTH CIRCUIT


The Ninth Circuit and district courts of California handed down noteworthy decisions on a variety of topics in 2012. In Strategic Diversity, Inc. v. Alchemix Corp., the Ninth Circuit held that plaintiffs’ Section 10(b) claim seeking rescission or a rescissionary measure of damages must still demonstrate economic loss and loss causation, even when the plaintiffs were not asking for monetary damages. In In re Rigel Pharmaceuticals, Inc. Securities Litigation, the Ninth Circuit affirmed a district court order dismissing a complaint, holding that plaintiffs’ allegations of false statements related to a drug’s efficacy were insufficient insofar as they challenged the statistical methodology applied to a clinical study without alleging that defendants had misrepresented that methodology, analysis, or conclusions. In Gammel v. Hewlett-Packard Co., the Central District of California dismissed a complaint alleging that several executives made false statements regarding a future product line, concluding that several of the statements were protected by the safe harbor under the Private Securities Litigation Reform Act of 1995. In Krieger v. Atheros Communications, Inc., the Northern District of California granted a motion to dismiss for failure to sufficiently allege loss causation where plaintiff had failed to connect any proxy misstatements or omissions with an actual economic harm. In Laborers’ Local v. Intersil, the Northern District of California applied Delaware law to a derivate suit alleging demand futility, and granted a motion to dismiss upon determining that the two-prong Aronson test was not met because the complaint failed to allege that the officers and directors were “interested” or that there was a reasonable doubt that the approval of the compensation was entitled to the protection of the business judgment rule.



a. In re SunPower Securities Litigation, No. C 09-5473 RS, 2011 WL 7404238 (N.D. Cal. Dec. 19, 2011)

Plaintiffs filed a putative class action under Sections 10(b) and 20(a) of the Exchange Act and Rule 10b5-1 against a solar panel company, its officers, the company’s former corporate controller and a former financial director for making false and misleading statements that were predicated on improperly manipulated accounting data. Applying the PSLRA heightened pleading standards, the court denied the motion to dismiss against the company and the officers, finding that plaintiffs had pleaded sufficient facts giving rise to a strong inference that these defendants had acted with scienter because the amended complaint included allegations of how the company’s accounting operations were controlled and monitored by the defendant officers. In particular, the amended complaint included (i) allegations that certain of the company’s accounting personnel were directly responsible for carrying out the accounting scheme, (ii) allegations that such personnel were in close and continuous communication with the officers and (iii) a description of the process by which manual changes to the accounting entries were made and how access to make such changes was limited primarily to the officers. Based on these allegations, the court determined that there was no real question that the accounting entries were deliberately falsified, and that under a holistic view, a reasonable person could deem the

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inference that the defendant officers were aware of the accounting manipulation to be cogent and compelling. The court, however, granted the motion to dismiss against the former corporate controller and the former financial director because these defendants did not make any misrepresentations to the public and plaintiffs failed to show that where an alleged “scheme” consists of making misleading or deception public statements, liability can be imposed against “non-speakers” merely by re-labeling the claim.

b. Cement Masons & Plasterers Joint Pension Trust v. Equinix, Inc., No. 11-01016 SC, 2012 WL 685344 (N.D. Cal. Mar. 2, 2012)

Plaintiff pension fund asserted claims under Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 against defendant data center provider and its CEO and CFO, alleging that the company’s stock price was artificially inflated due to allegedly false and misleading statements made by the defendants. Applying the PSLRA heightened pleading standards, the court granted the motion to dismiss, finding that plaintiff had failed to properly plead falsity and scienter. Specifically, the court held that defendants’ statements relating to the company’s pricing were too vague, generalized and unspecific to be actionable, concluding that the company only offered discounts to a select number of customers as part of a business strategy announced at the beginning of the class period and there was no indication that pricing varied for the rest of the company’s customer base. The court further held that the CFO’s statement about having a “high degree of confidence” in their ability to offer guidance could not support a claim for securities fraud because it constituted a non-actionable expression of corporate optimism. With regard to scienter, the court noted that plaintiff’s allegations of fraud were undercut by the fact that the complaint did not allege why the defendants would knowingly overstate their forecast by a few percentage points, only to reveal the truth 10 weeks later. The court also found that plaintiff’s argument that defendants had a duty to update the initial third quarter and 2010 fiscal year forecasts failed for several reasons: (1) the PSLRA does not impose a duty to update forward-looking statements, (2) even if a duty to update forward-looking statements existed, it would be unreasonable to apply it when a forecast varies by only one or two percentage points (to hold otherwise would place companies in the untenable position of having to constantly update the public about de minimis changes in forecasts) and (3) the defendants ultimately provided investors with an updated forecast as soon as they had sufficient information to do so.

c. Police Retirement System of St. Louis v. Intuitive Surgical, Inc., No. 10-CV-03451-LHK, 2012 WL 1868874 (N.D. Cal. 2 May 22, 2012)

Plaintiff shareholders filed a putative class action under Sections 10(b) and 20(a) of the Exchange Act against a medical device manufacturer and certain officers, including the CEO and CFO, for making false and misleading statements or omissions regarding the sales of company’s main medical device. The court granted defendant’s motion to dismiss the second amended complaint with prejudice, finding that plaintiffs failed to adequately allege a misrepresentation or omission of material fact and that plaintiffs failed to allege with particularity facts that would support a strong inference of scienter on the defendants’ part. Specifically, the court found that 12 of the statements were forward-looking statements accompanied by meaningful cautionary language, and thus could not serve as the basis for a securities fraud claim under the PSLRA. The court also held that four of the statements were “vague, generalized assertions of corporate

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optimism or statements of mere puffery,” and were not actionable. With respect to the remaining 15 statements, the court held that the plaintiffs “failed to show the alleged omissions affirmatively created an impression of a state of affairs that differs in a material way from the one that actually existed.” Finally, the court held that plaintiffs failed to allege facts giving a “strong inference” that the defendants acted with “the required state of mind,” where the plaintiffs based their scienter allegations on a “core operations” theory and on evidence regarding the individual defendants’ financial gains. Although the court noted that “while personal financial gain may weigh heavily in favor of a scienter inference,” the rise in compensation did not support an inference of scienter, for “if simple allegations of pecuniary motive were enough to establish scienter, virtually every company in the United States that experiences a downturn in stock price could be forced to defend securities fraud.”

d. In re Rigel Pharmaceuticals, Inc. Securities Litigation, No. 10-17619, 2012 WL 3858112 (9th Cir. Sept. 6, 2012)

Plaintiff brought a securities fraud action pursuant to Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5, and Sections 11, 12(a)(2), and 15 of the Securities Act. Plaintiff alleged that defendant pharmaceutical company and certain officers made material misstatements concerning the results of a clinical drug trial and about partnership prospects for the Company. Specifically, plaintiff claimed that three types of false statements were made: (1) statements related to the drug’s efficacy, (2) statements related to the drug’s safety and (3) statements about the Company’s future partnership prospects. The District Court dismissed the complaint in its entirety, and the Ninth Circuit affirmed. The Ninth Circuit held that plaintiff failed to plead falsity regarding the statements related to the drug’s efficacy because the complaint merely challenged the particular statistical methodology applied to defendant’s clinical study, without alleging that defendants misrepresented the methodology, analysis, or conclusions. Plaintiff also failed to plead falsity regarding the statements related to the drug’s safety because the initial press release describing the “key” side effects of the drug clearly stated that it only listed some of the reported side effects and clearly stated the basis upon which the Company decided that those specific side effects would be included. Finally, plaintiff failed to plead falsity regarding the statements about the Company’s partnership prospects because the complaint failed to allege that the Defendants did not believe that the statements they made were accurate. With respect to scienter, the court found that the complaint did not allege that defendants believed any of their statements were untrue because defendants’ interest in pursuing routine corporate objectives, such as desire to raise capital or increase individual compensation, were insufficient, without more, to allege scienter. As such, plaintiff’s Section 10(b) claim was properly dismissed. The court concluded that the substance of plaintiff’s Section 11 claim was grounded in fraud and subject to heightened pleading requirements, failing for the same reasons as plaintiff’s Section 10(b) claim.

e. Gammel v. Hewlett-Packard Co., No. SACV 11-1404 AG, 2012 WL 5275332 (C.D. Cal. Aug. 29, 2012)

Plaintiff shareholders alleged that defendant company and three of its executives violated Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 by issuing allegedly false or misleading statements regarding defendant technology company’s intentions to develop an acquired product line. Plaintiffs alleged that certain of defendants’ statements were knowingly

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false when made because they related to the future development of the acquired product line when no such development was planned. Plaintiffs argued that these statements misled investors, who were subsequently harmed when defendant company’s stock price fell by over 25 percent after it abandoned the product line several months later. Defendants moved to dismiss the claims, and the court granted the motion finding that several of the allegedly false statements were forward-looking statements covered by the PSLRA safe harbor or were inactionable puffery. Finally, the court held that plaintiffs had failed to offer sufficient proof that the remaining allegedly false statements were knowingly false when made. Therefore the court dismissed all claims against the defendants with leave to amend.

f. Curry v. Hansen Medical, Inc., No. C 09-5094, 2012 WL 3242447 (N.D. Cal. Aug. 10, 2012)

Plaintiff shareholders filed a federal securities fraud class action against a medical company and several of its officers after the company restated two and a half years of improperly reported revenues shortly after a public offering. The court granted in part defendants’ motion to dismiss claims under Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5. In doing so, the court dismissed a Rule 10b-5 claim against one officer because plaintiffs failed to allege that he was the “maker” of any false or misleading statements, as required under Janus Capital Group, Inc. v. First Derivative Traders, 131 S. Ct. 2296 (2011). In upholding other claims, the court found that in the context of a vicarious liability Rule 10b-5 claim, scienter could be imputed to the company because the complaint adequately alleged an individual defendant’s scienter and this individual undertook his scheme in the scope of his employment to benefit the company.

g. Kovtun v. Vivus, Inc., No. C 10-4957, 2012 WL 4477647 (N.D. Cal. Sept. 27, 2012)

Plaintiffs alleged that defendant pharmaceutical manufacturing company, and certain of its officers and directors, violated Section 10(b) of the Exchange Act and Rule 10b-5 by issuing false or misleading statements concerning the results of pharmaceutical trials of a product under development, as well as the likelihood that the product would be approved by the Food and Drug Administration (FDA). Plaintiffs also alleged that the individual defendants violated Sections 20(a) and 20A of the Exchange Act. Defendants moved to dismiss plaintiffs’ Section 10(b) and Rule 10b-5 claims on the grounds that: (1) defendants’ statements concerning the likelihood of FDA approval and safety of its pharmaceutical product were not materially false or misleading, (2) defendants’ statements were protected by the PSLRA safe harbor and (3) plaintiffs failed to allege scienter. The individual defendants moved to dismiss plaintiffs’ Section 20(a) and Section 20A claims on the grounds that plaintiffs failed to plead a primary securities law violation. The court agreed with defendants on all grounds, granting the motion to dismiss.

h. In re Diamond Foods, Inc. Securities Litigation, No. C 11-05386, 2012 WL 6000923 (N.D. Cal. Nov. 30, 2012)

Plaintiffs alleged that defendant company, its CEO, CFO and outside auditor violated Sections 10(b) and 20(a) of the Exchange Act by issuing false and misleading statements that deliberately understated commodity costs of walnuts and improperly accounted for payments

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made to walnut growers to increase apparent profits. Plaintiffs further alleged that this fraud was motivated in part by a desire to inflate defendant company’s share price because the company was seeking to use its stock to acquire a snack chips brand. Defendants moved to dismiss plaintiffs’ claims for failure to plead scienter and loss causation under the PSLRA. The court denied the company and individual defendants’ motions to dismiss and granted the outside auditor’s motion to dismiss. The court found that defendants adequately pled scienter as to the company and individual defendants. Plaintiffs’ allegations regarding the magnitude of the company’s wrongful accounting and GAAP violations, as well as the company’s subsequent inconsistent explanations for the payments made to walnut growers, gave rise to a strong inference of the company’s scienter. As to the individual defendants, the court found that CW statements and allegations regarding statements that the CEO and CFO made to analysts were sufficient to plead their direct involvement in and awareness of the accounting related to the company’s walnut business. The court rejected defendants’ argument that the fact that the CEO and CFO did not sell and instead increased their stock holdings during the class period negated an inference of scienter, noting that these stock purchases were consistent with the alleged motive to inflate share prices. In addition, the court held that plaintiffs adequately pled loss causation by alleging that defendants’ fraud resulted in inflated stock prices and that the stock price plummeted upon disclosure of the alleged fraud. The court dismissed the claims as to the outside auditor, finding that plaintiffs failed to plead scienter because they did not allege sufficient facts regarding the auditor’s actions, procedures and what documents or information it considered or reviewed. Allegations that the accounting errors were so obvious that no reasonable accountant would have made the same decisions were insufficient to meet the heightened pleading standards of the PSLRA.


a. In re Yahoo! Inc. Securities Litigation, No. C 11-02732 CRB, 2012 U.S. Dist. LEXIS 113036, 2012 WL 3282819 (N.D. Cal. Aug. 10, 2012)

Plaintiff shareholders allege that defendant company and three of its executives violated Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 by issuing allegedly false or misleading statements regarding defendant company’s investment in a Chinese company. Plaintiffs alleged that certain of defendants’ statements were false and misleading because defendants did not disclose certain information about the Chinese company’s restructuring that mislead investors into believing that defendant company still partially owned and controlled the Chinese company. The court determined that defendants had not violated any duty to disclose this information, as defendants’ statements about the Chinese company were not in conflict with the more specific explanation plaintiffs believe should have been given. While the court found that certain of defendants’ statements did give rise to a duty to correct, as they were arguably misleading, the court found those statements to be non-actionable because defendants’ disclosure of the Chinese company’s restructuring was made within a reasonable time after defendants were first notified about the situation.

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b. In re HP Derivative Litigation, No. 5:10–cv–3608 EJD, 2012 WL 4468423 (N.D. Cal. Sept. 25, 2012)

Plaintiff shareholders filed a derivative action against former company CEO and company’s board of directors, alleging that the board had committed corporate waste or otherwise breached its duties to company by approving former CEO’s separation agreement. Plaintiffs further alleged that former CEO and other members of the board knew the CEO’s employment agreement had expired, yet still filed with the SEC and disseminated to company shareholders a proxy statement, which falsely represented that the employment agreement was still in effect. Defendants moved to dismiss, and the court granted the motion. The court found that plaintiffs failed to show that the board’s approval of the separation agreement was not in the company’s best interest, and that plaintiffs failed to plead facts showing the materiality of the alleged misstatements about the employment agreement or a connection between the alleged misstatement and the shareholder vote.

3. Scienter

a. In re Finisar Corp. Derivative Litigation, No. 06-cv-07660, 2012 WL 2873844 (N.D. Cal., July 12, 2012)

Plaintiff investors brought a derivative suit on behalf of a corporation against individual officer and director defendants under Sections 10(b), 20(a) and 14(a) of the Exchange Act and state law, alleging material misstatements and omissions regarding backdated stock option grants. The district court dismissed plaintiffs’ complaint for failure to allege misstatements and scienter, and the Ninth Circuit reversed and remanded. On remand, the district court denied in part and granted in part defendants’ motion to dismiss. The court first addressed plaintiffs’ claims under Section 10(b). The court dismissed plaintiff’s claims as to five of the 12 grants as untimely under the five-year statute of repose. As to the remaining grants, the court found that plaintiffs adequately pled material misstatements because the relevant SEC filings indicated that stock option grants would only be valuable if the price of common stock increased over the exercise price and that the company had complied with an Accounting Principles Board opinion governing the accounting for stock options grants. After holding that well-pleaded allegations of deliberate backdating would be sufficient to rebut the business judgment rule, the court then engaged in a defendant-by-defendant consideration of whether plaintiffs had adequately pled scienter. The court found that plaintiffs alleged sufficient facts to create a strong inference that five of the nine individual defendants knowingly participated in the backdating scheme based on their receipt of and approval of backdated options and their positions at the company at the time the options were granted. The court also found that plaintiffs adequately alleged the company’s reliance, rejecting defendants’ argument that the company could not have relied where its officers and directors were aware of the scheme.

b. City of Royal Oak Retirement System v. Juniper Networks, Inc., 880 F. Supp. 2d 1045 (N.D. Cal. 2012)

Plaintiff shareholders alleged that defendant technology company and certain of its officers and directors violated Section 10(b) of the Exchange Act and Rule 10b-5 by issuing allegedly false or misleading statements. In particular, plaintiffs alleged that (a) defendant

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company’s growth forecasts were false or misleading because various operational and sales difficulties rendered those forecasts unattainable and (b) the company failed to adequately disclose the impact of new accounting standards, which permitted it to recognize revenue in earlier reporting periods. The court granted defendants’ motion to dismiss. First, the court found that defendants’ financial forecasts were either protected by the PSLRA safe harbor for forward-looking statements or were non-actionable statements of corporate optimism. Second, the court found that plaintiffs failed to allege that defendants’ financial forecasts were false or misleading, because they failed to allege an “analytical link” between alleged business difficulties and the impossibility of the company meeting its financial goals. In addition, plaintiffs failed to allege falsity as to defendants’ failure to disclose the impact of its adoption of new financial standards, because defendants’ disclosures complied with Financial Accounting Standards Board (FASB) disclosure requirements. Finally, the court found that plaintiffs failed to allege specific facts sufficient to plead scienter. The court rejected plaintiffs’ argument that the court could infer the individual defendants’ knowledge of the impact of the new accounting practices based on their role at the company, finding that plaintiffs had failed to plead that this was one of the “exceedingly rare” cases in which a plaintiff may reply solely on the “core operations” inference without particularized allegations. In addition, the court rejected plaintiffs’ argument that the individual defendants’ stock sales demonstrated improper motive, finding that most of the sales were either de minimis or made pursuant to a Rule 10b5-1 trading plan. As to one defendant’s unusually large stock trades, the court found this allegation insufficient to support a strong inference of scienter absent some corroborating evidence. Regardless, any inference of scienter created by these trades was offset by the equally compelling competing inferences that the Individual Defendants’ believed the company would be able to meet forecasts.

c. Cho v. UCBH Holdings, Inc., 2012 WL 3763629 (N.D. Cal. Aug. 29, 2012)

Plaintiff shareholders filed putative class actions alleging that a holding company, bank and certain of its employees issued materially false and misleading statements concerning the company’s allowance for loan loss and provision for loan loss and falsely represented that the company’s financial reporting controls were effective. Reviewing defendants’ motions to dismiss claims against them in the third amended complaint, the court granted in part and denied in part. The court denied the motion to dismiss the Section 10(b) and Rule 10(b)-5 claims against the CEO, finding sufficient support for a strong inference of scienter where plaintiffs specified how he had engaged in deliberate misconduct. The court granted the other individual defendants’ motion to dismiss on these claims because plaintiffs failed to allege sufficient facts to support a strong inference of scienter against them by relying on unproven allegations from other complaints and documents, a consent to entry of final judgment in an SEC action that neither admitted or denied the allegations against them, and a guilty plea by a former bank employee that did not name these individuals. However, in doing so, the court found that the guilty plea could be imputed to the bank based on respondeat superior and held that plaintiffs had sufficiently alleged a primary violation of Section 10(b) and Rule 10(b)-5 by the bank. The court further denied the motions to dismiss the Section 20(a) claims against 10 bank and company employees who were adequately alleged to exercise control over certain operations and/or reporting obligations of the company and bank. The court granted the motions to dismiss the Section 20(a) claims for two individuals because plaintiffs failed to plead that one of these

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defendants exercised day-to-day control over the bank’s loan portfolio or that the other defendant had signed an SEC filing containing materially false and misleading statements.

d. Westley v. Oclaro, Inc., No. C-11-2448 EMC, 2012 WL 4343401 (N.D. Cal. Sept. 21, 2012)

Plaintiff shareholder filed a putative class action under Sections 14(a) and 20(a) of the Exchange Act against a wireless equipment manufacturing company and its directors following the company’s merger with a wireless technology and services provider. Plaintiff shareholder also filed a claim for an equitable assessment of attorneys’ fees and expenses in connection with a Delaware preliminary injunction proceeding, which resulted in subsequent disclosures that provided the shareholders with the required additional information to approve the merger. The court granted the motion to dismiss because plaintiff failed to sufficiently allege loss causation. Specifically, the court determined that the timing of the merger and the perceptions and effects present in the market place in the period leading up to the merger, rather than any misstatement or omission in the proxy, caused any alleged loss. The court found that plaintiff had failed to connect any proxy misstatements or omissions with an actual economic harm. The court also determined that the amended complaint failed to allege facts showing that the alleged omissions were material or that statements made in the disclosures were false or misleading, and also failed to plead with particularity facts that gave rise to a strong inference of negligence. With regard to plaintiff’s request for an equitable award of attorney’s fees and expenses, the court denied the request because it was the Delaware state proceeding, not the federal California proceeding, that conferred a substantial benefit to the putative class.

4. Loss Causation

a. Strategic Diversity, Inc. v. Alchemix Corp., 666 F.3d 1197 (9th Cir. 2012)

An individual investor and his wholly-owned company (appellants) sued a start-up company, its CEO and a related holding company (appellees) seeking rescission of a stock purchase transaction based on violations of Section 10(b) of the Exchange Act and various state securities and common law claims. The district court granted summary judgment to appellees on all claims, holding that appellants’ state and federal securities claims were time-barred, or that, in the alternative, they failed for lack of demonstrated damages. The Ninth Circuit affirmed in part and reversed in part, remanding certain questions back to the district court for further proceedings. The court rejected appellants’ argument that they did not need to demonstrate economic loss and loss causation because their suit sought rescission and not monetary damages. The court held that plaintiffs’ Section 10(b) claim seeking rescission or a rescissionary measure of damages still must demonstrate economic loss and loss causation. The court then remanded the question of damages, holding that although true rescission was not warranted in this case, the district court had the discretion to apply a rescissionary measure of damages, which calculates the monetary equivalent of true rescission and looks at the position the parties would have been in had the transaction not occurred — the district court only considered damages under an “out-of-pocket” or “market” theory and found no damages. The court upheld the district court’s dismissal of various state law claims, and vacated and remanded the district court’s dismissal of others.

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b. Krieger v. Atheros Communications, Inc., No. 11-CV-00640-LHK, 2012 WL 1933559 (N.D. Cal. May 29, 2012)

Plaintiff shareholder filed a putative class action under Sections 14(a) and 20(a) of the Exchange Act against a wireless equipment manufacturing company and its directors following the company’s merger with a wireless technology and services provider. The court granted the motion to dismiss because plaintiff failed to sufficiently allege loss causation. Specifically, the court determined that the timing of the merger and the perceptions and effects present in the marketplace in the period leading up to the merger, rather than any misstatement or omission in the proxy, caused any alleged loss. The court found that plaintiff had failed to connect any proxy misstatements or omissions with an actual economic harm. The court also determined that the amended complaint failed to allege facts showing that the alleged omissions were material or that statements made in the disclosures were false or misleading, and also failed to plead with particularity facts that gave rise to a strong inference of negligence.

5. Demand Futility / Business Judgment Rule

a. Laborers’ Local v. Intersil, No. 5:11-CV-04093 EJD, 2012 WL 762319 (N.D. Cal. Mar. 7, 2012)

Plaintiff shareholder filed a derivative suit against a semiconductor company and certain of its officers and directors for breach of fiduciary duty and unjust enrichment for approving an executive compensation plan that was later disapproved by 56 percent of its shareholders in a non-binding say-on-pay vote mandated by the Dodd-Frank Act. Plaintiff also alleged that the company’s independent compensation consultant aided and abetted the officers and directors in their breach of fiduciary duty. Applying Delaware law, the district court granted the motion to dismiss with leave to amend, holding that the complaint did not adequately allege that demand was futile under the two-prong Aronson test because it failed to allege that the officers and directors were “interested” or that there was a reasonable doubt that the approval of the compensation was entitled to the protection of the business judgment rule. First, the possibility of personal liability for the officers and directors was insufficient to create doubt about their independence or disinterestedness. Plaintiff also failed to show that a majority of the board received financial benefits from the transaction, or that they were under the influence of the one board member who received such benefits. Second, the court found that negative say-on-pay votes have “substantial evidentiary weight” in determining whether to rebut the business judgment rule presumption. However, in this case, the negative say-on-pay vote by itself was insufficient to rebut the business judgment rule. The court also dismissed plaintiff’s aiding and abetting breach of fiduciary duty claim against the compensation consultant because the complaint failed to allege any specific acts in support of its claim.

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VIII. TENTH CIRCUIT


The courts in the Tenth Circuit and issued several noteworthy decisions in 2012 in the areas of scienter and Rule 23’s adequacy of representation requirement for class certification. In In re Level 3 Communications, Inc. Securities Litigation, the Tenth Circuit affirmed the dismissal of Rule 10b-5 claims against a company and five of its senior executives, finding that investors’ mere allegation that defendants made later statements that contradicted earlier, allegedly false statements was insufficient to support an inference of scienter. The District of Utah denied defendants’ motion for summary judgment on the claim of primary liability in Cather v. Isom, finding that a reasonable juror could conclude that defendants knew or should have known that their allegedly untrue statements would have been communicated to investors. In United Food and Commercial Workers Union v. Chesapeake Energy Corp., the Western District of Oklahoma held that the monitoring agreement between lead counsel and lead plaintiff did not create a conflict of interest that would render lead plaintiff an inadequate representative, and instead found that the monitoring agreement demonstrated lead plaintiff’s “involvement in, and awareness of, the financial issues involved in the litigation” and thus did not defeat class certification.


1. Scienter

a. In re Level 3 Communications, Inc. Securities Litigation, 667 F.3d 1331 (10th Cir. 2012)

Plaintiff investors asserted class claims under Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 against defendant company and five of its senior executives, alleging that the defendants made misleading statements to investors regarding the progress and success of the company’s efforts to integrate specific acquired companies. The district court dismissed the complaint, finding that lead plaintiff did not adequately allege that the statements at issue were untrue or misleading when made. The Tenth Circuit agreed that the majority of defendants’ statements were nothing more than puffery, but held that three of defendants’ statements were “inconsistent with the facts on the ground” at the time they were made and therefore potentially actionable. Despite this finding, the Tenth Circuit affirmed the district court’s dismissal of the complaint on the grounds that plaintiffs’ allegations did not support a strong inference of scienter. The court held that later disclosures by defendants that contradicted prior statements did not, without more, create a plausible inference that defendants knowingly misled investors with their initial statements.

2. Class Action Certification

a. United Food and Commercial Workers Union v. Chesapeake Energy Corp., 281 F.R.D. 641 (W.D. Okla. 2012)

Plaintiff shareholders brought a class action complaint against defendant energy corporation and certain of its officers, alleging violations of Sections 11, 12(a)(2) and 15 of the

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Securities Act. Specifically, plaintiffs alleged that the registration statement and prospectus associated with the company’s common stock offering included material misrepresentations and omissions regarding the risks associated with margin loans to the CEO and certain contracts hedging the company’s gas and oil production. Lead plaintiff pension fund moved for class certification and the defendants opposed, claiming that lead plaintiff was an inadequate class representative. Defendants challenged lead plaintiff’s adequacy on several grounds, including a potential conflict of interest based on its monitoring agreement with lead counsel. Under the terms of the monitoring agreement, lead counsel was to maintain a list of lead plaintiff’s investments and, when appropriate, recommend that lead plaintiff initiate or join existing lawsuits. The agreement neither required that lead plaintiff follow lead counsel’s advice with respect to initiating or joining lawsuits nor that lead plaintiff retain lead counsel when pursuing recommended legal actions. The court rejected this challenge and granted plaintiff’s motion for class certification. The court found that defendants had not presented sufficient evidence of an actual or potential conflict of interest arising from the monitoring agreement. To the contrary, the court noted that “monitoring agreements like the one in this case illustrate a lead plaintiff’s involvement in, and awareness of, the financial issues involved in the litigation,” and the absence of a monitoring agreement “might be seen as demonstrating a lack of diligent investment oversight.” The court also rejected defendants’ argument that at the class certification stage, “difficulties in tracing” purchases to particular registration statements could prevent plaintiff from satisfying the predominance requirement.

3. Primary Liability

a. Cather v. Isom, No. 2:09-CV-52 TS, 2012 WL 28723 (D. Utah Jan. 5, 2012)

Plaintiff investor asserted claims against defendant company and its executives under Sections 10(b) and 20(a) of the Exchange Act. Plaintiff had invested in defendant company after being told by a non-party marketer that she would receive two percent interest a month on her investment. When interest payments stopped, plaintiff brought suit, alleging that defendants made material misstatements and that they should be held liable as control persons for material misstatements made the non-party marketer. Defendants moved for summary judgment, and the court granted the motion in part and denied it in part. The court granted summary judgment for defendants as to the control person liability claim, finding that plaintiff failed to point to any evidence showing that the non-party marketer acted with scienter and had thus had failed to establish a primary violation upon which to predicate control person liability. The court, however, refused to grant defendants’ motion for summary judgment as to plaintiff’s claim for primary liability. The court pointed to the non-party marketer’s statement that defendants had made the same representations to him that he had repeated to plaintiff, and held that a reasonable juror could conclude that defendants knew that their own statements would be communicated to investors.

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IX. ELEVENTH CIRCUIT


During 2012, courts within the Eleventh Circuit issued noteworthy decisions in the areas of scienter, loss causation, and the standard for pleading misstatements and omissions. The Eleventh Circuit affirmed the dismissal of the claim in Hubbard v. BankAtlantic Bancorp because plaintiff failed to properly disaggregate losses resulting from defendant’s alleged misrepresentations from losses caused by the general economic downturn. The Middle District of Florida dismissed the plaintiff’s complaint in City of St. Clair Shores v. Lender Processing Services on the grounds that plaintiff’s conclusory allegations regarding defendants’ fraudulent scheme were insufficient to create a strong inference of scienter, even though plaintiffs had sufficiently alleged both material misrepresentations and loss causation. In Meyer v. St. Joe Co., the Northern District of Florida held that neither a presentation negatively characterizing publicly available information nor an announcement of a regulatory investigation qualified as a “corrective disclosure” for which plaintiff could plead loss causation. Finally, in Kinnett v. Strayer Education, Inc., the Middle District of Florida found that because defendant education corporation had warned plaintiff shareholders of the volatility of enrollment numbers, plaintiffs could not successfully allege material misrepresentation. Finally, the Southern District of Florida granted the SEC’s motion for summary judgment in SEC v. Merkin on the grounds that the defendant lawyer’s false statements that his client was not under investigation by the SEC were material and that defendant acted with scienter.



a. Kinnett v. Strayer Education, Inc., 8:10-cv-2728-T-23MAP, 2012 WL 933285 (M.D. Fla. Jan. 3, 2012)

Plaintiff shareholders claimed that defendants, an educational services company and certain of its officers, engaged in fraudulent practices that over-inflated their stock price and violated Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5. These practices included increasing student enrollment by not withdrawing from enrollment figures students who had asked to be withdrawn, recruiting unqualified people and not explaining to students the complete costs of attendance. The court dismissed the complaint, finding that plaintiffs failed to plead a cogent and compelling theory either that defendants acted knowingly or were recklessly negligent in not knowing about improper enrollment practices. The court also found that defendants made no false or misleading statements because their projected enrollment was clearly identified as an estimate, and defendants warned plaintiffs that enrollment was volatile. As a result, plaintiffs could not establish that any of defendants’ statements caused plaintiffs’ losses.

b. SEC v. Merkin, 2012 U.S. Dist. LEXIS 155679 (S.D. Fla. Oct. 2, 2012)

The SEC alleged that the defendant, an attorney, violated Section 10(b) of the Exchange Act and Rule 10b-5 by making false statements in Attorney Letters to the over-the-counter

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securities market (OTC Markets). In four separate letters dating from April 2008 to December 2010, the defendant falsely stated that StratoComm, a company he represented as counsel, was not, to his knowledge, under investigation by the SEC. The court granted the SEC’s motion for summary judgment, holding that the defendant made material statements in connection with the purchase or sale of securities, and that he acted with scienter. The court’s ruling explained that the defendant, in drafting and signing the letter, effectively “made” the statements contained in them, even though they were published on the OTC Markets website. The statements were “material” because a reasonable investor would consider the fact that a company was under investigation by the SEC to be important in deciding whether to buy or sell the company’s stock. The statements were made “in connection with the purchase or sale of securities” because the statements were made available to the general public and investors would have relied upon the content of those statements in making investment decisions. Finally, the court reasoned that scienter was established because the defendant knew that the statements were false at the time that he made them, or, at the very least, that he “acted with severe recklessness in that the four letters contained highly unreasonable misrepresentations that presented a danger of misleading buyers or sellers which were known to [him].”

2. Scienter

a. City of St. Clair Shores v. Lender Processing Services, No. 3:10–cv–1073–J–32JBT, 2012 WL 1080953 (M. D. Fla. Mar. 30, 2012)

Plaintiff shareholders alleged that defendant officers and directors of a mortgage processing services company engaged in a fraudulent scheme, including making false and misleading statements in press releases, conference calls, and SEC filings and relying on illicit business practices to artificially inflate stock prices and revenue. Although the court found that the complaint sufficiently alleged falsity and loss causation, the court dismissed the complaint because the conclusory allegations in the complaint were not sufficient to create a plausible inference of scienter on behalf of each defendant and as to each violation, much less facts rising to the level of a “strong inference of scienter,” as required under the PSLRA.

3. Loss Causation

a. Meyer v. St. Joe Co., No. 5:11–cv–27/RS–EMT, 2012 WL 94584, 2012 WL 933285 (N.D. Fla. Jan. 12, 2012)

Plaintiff brought a putative class action against defendant real estate development company and certain of its former and current officers and directors, claiming violations of Sections 10(b) and 20(a) of the Exchange Act. Plaintiff alleged that an investor presentation revealed that the company had not taken the correct impairment charges and had therefore overstated its asset values and earnings. Plaintiffs further alleged that the presentation and a subsequent announcement by the SEC that it was conducting an investigation qualified as corrective disclosures. The court dismissed the complaint, holding that it lacked sufficient allegations of loss causation. The court found that a negative characterization of previously disclosed facts does not constitute a corrective disclosure for purposes of loss causation and that, in any event, the presentation at issue was not a corrective disclosure because it consisted

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entirely of publicly available information. In particular, although it recognized that loss causation may be established where an analyst’s opinion identifies, reveals, or corrects a prior misstatement, omission, or accounting practice, the court determined that the presentation suggested future actions the company should follow, rather than past actions it failed to take, and that the company disclosed the calculations used for impairment charges and did not omit or misrepresent any of the data used in the calculations. The court noted a split in authority as to whether the announcement of a regulatory action can qualify as a corrective disclosure, and held that the SEC’s investigation announcement alone did not reveal impropriety or provide corrective information. Accordingly, it was not a corrective disclosure for purposes of pleading loss causation.

b. Hubbard v. BankAtlantic Bancorp, Inc., 688 F.3d 713 (11th Cir. 2012)

Plaintiff shareholders brought suit against defendant financial institution, alleging that it fraudulently misled the public about the deteriorating quality of its real estate portfolio, in violation of Section 10(b) of the Exchange Act and Rule 10b-5. At trial, plaintiff sought to prove that defendant falsely denied any reason for concern, despite the fact that as early as the fall of 2006, defendant had reason to be worried about the credit quality of its commercial real estate portfolio. In an 8-K filed in April 2007, defendant first disclosed concerns about its real estate portfolio but failed to disclose several areas of risk, including a $21.2 million loan that had been designated “substandard.” When full disclosures were finally made in an 8-K filed in October 2007, defendant’s stock price fell by 38 percent. The jury returned a verdict partially in favor of plaintiff, and defendant moved for judgment as a matter of law. The district court granted defendant’s motion, and the appellate court affirmed, holding that the plaintiff had failed to prove loss causation by failing “to adequately separate losses caused by fraud from those caused by the 2007 collapse of the Florida real estate market.”

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X. D.C. CIRCUIT

1. Scienter

a. In re Federal National Mortgage Association Securities, Derivative & ERISA Litigation, No. 04-1639 (D.D.C. Oct. 16, 2012)

Plaintiffs alleged that defendant Fannie Mae and certain of its executives, including its CFO, violated Section 10(b) of the Exchange Act and Rule 10b-5 by intentionally manipulating earnings and violating GAAP, thereby causing losses to investors. With respect to the CFO specifically, plaintiffs alleged that he knowingly made false statements about the soundness of Fannie Mae’s accounting, risk management and internal controls. Defendant CFO moved for summary judgment on the grounds that plaintiffs failed to prove he acted with scienter. The judge found that the circumstantial evidence presented against the defendant was insufficient for a reasonable jury to conclude that the defendant acted with intent to deceive or an extreme departure from the standard of ordinary care. The court highlighted that plaintiffs had presented no direct evidence — including no witness testimony — that defendant CFO intended to deceive Fannie Mae’s investors or knew that Fannie Mae’s financial statements were not GAAP compliant. At worst, plaintiffs’ evidence demonstrated that the CFO had engaged in negligent behavior, which is not the equivalent of the requisite intent to deceive or conscious disregard of obvious risks.

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XI. DELAWARE COURTS


The Delaware Court of Chancery issued several noteworthy decisions in 2012. In Martin Marietta Materials, Inc. v. Vulcan Materials Co., the court enjoined a $4.5 billion hostile bid as a remedy for the bidder’s violation of a confidentiality agreement. In the In re El Paso Corp. Shareholders Litigation, though the court found that the target company’s conflicted CEO and investment bank likely could have secured a better price from the acquiror, the court declined to enjoin a merger because the target stockholders could vote against the merger if they found the price and/or process unappealing. In South v. Baker, the court held that when a plaintiff files a derivative suit without a thorough pre-suit investigation, the court will apply a mandatory “evidentiary presumption” that the plaintiff is not an adequate fiduciary representative for the corporation. Finally, in Feeley v. NHAOCG, LLC, after a recent opinion from the Delaware Supreme Court had left the issue unresolved, the court reiterated its position that default fiduciary duties apply to the manager of a Delaware LLC.


1. Fiduciary and Revlon Duties

a. In re El Paso Corp. Shareholder Litigation, 41 A.3d 432 (Del. Ch. 2012)

Plaintiff shareholders brought suit seeking to enjoin a merger allegedly tainted by the selfish motivations of the target’s CEO and an investment bank acting as the target’s financial advisor. In the lead up to the merger, the CEO placed in charge of negotiations did not disclose his interest in working with the acquiror to make a bid to buy a branch of the target. In addition, inadequate efforts were made to negate the conflict of interest that arose from the investment bank’s 19 percent ownership interest in the acquiring company and control of two of its board seats. The court criticized: (1) the target’s board for accepting its investment bank’s negotiating advice, notwithstanding the bank’s disclosed ownership interest in the acquiror, (2) the lead banker for failing to disclose his personal position in the acquiror and (3) the fee arrangement of a second investment bank brought in to “cleanse” the deal. The court criticized numerous board decisions made during the process as potentially tainted by either the CEO or investment bank’s conflicts of interest, including failing adequately to shop the target and allowing the acquiror to bargain down the price per share agreed to earlier. Although the court found that plaintiffs had shown a probability of success on the merits that the price obtained was less than could have been negotiated for by disinterested parties, an injunction was not appropriate because the target stockholders could vote against the merger if they found the price and/or process unappealing.

b. Auriga Capital Corp v. Gatz Properties, LLC, C.A. No. 4390-CS, 2012 WL 294892 (Del. Ch. Jan. 27, 2012)

Minority members in an LLC brought suit against the manager of the LLC alleging breaches of his fiduciary duties of loyalty and care. The manager and other investors had formed the LLC to build a golf course on property owned by the manager. After investing in the property, the LLC subleased the property to a large golf management corporation. Although it

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became clear that the golf management corporation would not renew its sublease, and the LLC’s primary source of revenue would be lost, the manager did little to prepare for this risk. Instead, the manager discouraged a credible buyer. After attempting — and failing — to purchase the company from minority members by providing them with misleading information, the manager conducted a sham auction through an incompetent marketing process to sell the LLC to himself. The court found that the manager of an LLC owed default fiduciary duties absent a contractual provision waiving those duties. The manager breached his fiduciary duties of loyalty and care by his bad faith (1) refusal to explore strategic alternatives, (2) refusal to consider the interest of a credible buyer (3) conduct in misleading minority members in connection with his offer to purchase their interests; and (4) conduct in running a sham auction in which he ultimately purchased the LLC. The court found that uncertainty with respect to damages cut against the manager because of his disloyalty, and it awarded one-half of plaintiffs’ attorneys’ fees on account of the managers’ bad faith.

c. Brenner v. Albrecht, C.A. No. 6514-VCP, 2012 WL 252286 (Del. Ch. Jan. 27, 2012)

Shareholders brought a federal securities class action after the company’s audit committee disclosed “unsubstantiated accounting entries” in its overseas manufacturing operations. Meanwhile, plaintiff shareholder exercised his right to inspect the company’s books and records, and, only thereafter, filed a derivative action claiming that the company’s directors breached their fiduciary duties in connection with the accounting errors by failing to exercise meaningful oversight over the company’s financial reporting (a Caremark claim). Defendants moved to stay the derivative action. The court granted the motion to stay, ruling that the practical considerations identified by defendants outweighed the prejudice plaintiff would suffer if the motion was granted. First, the court found that the derivative action risked prejudicing the company’s defense of the securities class action because the company was denying wrongdoing in the securities class action, and it was not practical for two actors — plaintiff and the company board — to pursue divergent strategies in two simultaneous actions on behalf of the same entity. Second, the court found that because the relief requested in the derivative claim depended primarily on the outcome of the securities class action, the primary case should go forward first.

d. In re Delphi Financial Group Shareholder Litigation, C.A. No. 7144-VCG, 2012 Del. Ch. LEXIS 45 (Del. Ch. Mar. 6, 2012)

Plaintiff stockholders brought suit against the target’s board after the board approved an acquisition that provided for different prices to be paid for the company’s two classes of common stock. The target had a dual-class capitalization structure under which the founder held only 13 percent of the economic interest, but retained voting control. The certificate of incorporation of the company provided that in the event of a sale of the company, the super-voting stock would be converted into the ordinary common stock and entitled to the same consideration as the other ordinary common stock. Notwithstanding this provision, the founder indicated to a potential acquiror that he would not consent to a sale unless a premium was paid for his control block. Ultimately, the parties agreed to a merger providing for the price differentials sought by the founder, which was conditioned on receiving approval from a majority of the publicly-held unaffiliated shares. The court found that, by negotiating for disparate consideration between the two classes of common stock, and only agreeing to support

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the merger if he received it, plaintiffs had a probability of success that the founder breached his duty of loyalty. The court concluded that an injunction, however, was not appropriate because the target’s stockholders were fully informed, the merger offered a substantial premium, no competing bidder was on the horizon, and the founder could be ordered to disgorge any premium to which he is ultimately determined to be not entitled.

e. In re K-Sea Transportation Partners L.P. Unitholders Litigation, C.A. No. 6301-VCP, 2012 Del. Ch. LEXIS 67 (Del. Ch. Apr. 4, 2012)

Plaintiff unitholders filed a lawsuit against a limited partnership challenging a merger with an unaffiliated third party, claiming that defendants had breached their contractual and fiduciary duties by approving the merger, and that public disclosures concerning the merger were materially misleading. Relying on the express provisions of the limited partnership agreement, the court granted defendants’ motion to dismiss these claims. The court held that the limited partnership agreement required plaintiffs to plead facts showing that defendants had (1) breached contractual and fiduciary duties and (2) in doing so, acted in bad faith. The agreement further provided that the defendants would be conclusively presumed to have acted in good faith if they relied on an expert opinion. Because defendants relied on a financial advisor’s fairness opinion in approving the merger agreement, defendants were found to have conclusively acted in good faith. Accordingly, defendants’ approval of the merger could not constitute a breach of any contractual or fiduciary duties.

f. In re Answers Corp. Shareholders Litigation, C.A. No. 6170-VCN, 2012 WL 1253072 (Del. Ch. Apr. 11, 2012)

Shareholder plaintiffs brought suit against the target’s board of directors, arguing that the board breached its fiduciary duties in connection with a merger, and that the buyout group aided and abetted that breach. The court denied defendants’ motion to dismiss, finding that plaintiffs adequately pled a breach of duty of loyalty as to three board members because those three board members were financially interested in the merger. Two board members were financially interested because they sought a sale of the target in order to achieve a liquidity event. Those two board members told a third board member (and CEO of the target) that management would be replaced if it could not achieve a sale of the company, therefore the CEO was financially interested to seek a sale of the company because of his desire to keep his job. The remaining board members acted in bad faith because they allegedly knew that the other three board members wanted to end the sales process quickly to the possible detriment of shareholders as a whole, and thus consciously disregarded their duties to seek the highest value reasonably available to the company’s shareholders. Plaintiffs adequately alleged that the buyout group aided and abetted the board’s breach because it (1) knew that the market price for the target’s stock would likely be rising and (2) used that information to push the board to end the sales process quickly to ensure the merger agreement could be executed before the target’s shareholders learned of the company’s favorable prospects.

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g. Zucker v. Andreessen, C.A. No. 6014-VCP, 2012 WL 2366448 (Del. Ch. June 21, 2012)

Plaintiff shareholder brought a derivative suit against a company’s board of directors in connection with a severance package for the company’s recently terminated CEO. Prior to the CEO’s termination, an internal investigation found that the CEO had filed inaccurate expense reports to conceal a personal relationship, and had breached the company’s standards of conduct. Although the company had no contractual obligation to pay the CEO any severance payments, the board entered into an agreement that provided him with cash and other severance benefits worth over $40 million. Plaintiff argued that (1) the severance agreement amounted to corporate waste; and (2) the board breached its duty of care by failing to adopt a long term succession plan before the CEO’s unexpected termination. Defendants moved to dismiss for failure to plead demand futility. The court granted the motion to dismiss. As to the waste claim, the court applied the “extreme test” for finding corporate waste, and found that there were a number of potentially rational reasons to provide the CEO with compensation in exchange for his acceptance of the severance agreement. Examples of valuable consideration provided by the CEO were: (1) the CEO’s release of any claims against the company, (2) the doubling of the time period of the CEO’s confidentiality obligation and (3) the CEO’s agreement to cooperate in succession planning. Additionally, at least some portion of the compensation could represent “reasonable” compensation for successful past performance. As to the succession plan claim, the directors did not face a substantial likelihood of personal liability because there was no precedent indicating that a failure to adopt a long-term succession plan amounted to a breach of duty. Therefore, the directors could not consciously have disregarded a known duty to act.

h. Seinfeld v. Slager, C.A. No. 6462-VCG, 2012 Del. Ch. LEXIS 139 (Del. Ch. June 29, 2012)

Plaintiff shareholder brought a derivative suit against a company’s board of directors in connection with various compensation decisions taken by the board. Among other things, plaintiff alleged that: (1) a $1.8 million payment to the retiring CEO was not contractually required and constituted waste, (2) a $1.25 million incentive payment to the retiring CEO was wasteful because it was not tax-deductible and constituted a breach of the directors’ duty to “minimize taxes” and (3) the board of directors paid themselves excessive compensation under the company’s stock plan. The court dismissed plaintiffs’ first two claims for failure to adequately plead demand futility. First, the court found that the $1.8 million payment did not constitute waste because there were a variety of reasons that a board might award executive bonuses for services already rendered. Second, the decision of the board to rely on a revenue ruling of the IRS in awarding the $1.25 million incentive award was within the business judgment of the board. Moreover, there is no per se fiduciary duty for a board to minimize taxes. Finally, defendants’ motion to dismiss plaintiff’s third allegation was denied. Because the shareholder-approved stock plan placed few, if any, bounds on the board’s ability to set its own stock awards, the court found the members of the board to be interested in the decision to award themselves a substantial bonus. Therefore, the board was required to show that the amounts they awarded themselves were entirely fair.

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i. In re Synthes, Inc. Shareholder Litigation, C.A. No. 6452-CS, 2012 Del. Ch. LEXIS 196 (Del. Ch. July 31, 2012)

Plaintiff shareholders filed suit against target company’s board of directors, arguing that the target’s board breached its fiduciary duties in connection with a mixed stock/cash merger. Plaintiffs alleged that a controlling stockholder breached his fiduciary duties when he refused to consider a different acquisition offer that would have cashed out all of the target’s minority stockholders, but required the controlling stockholder to remain as an investor in the company. The court granted defendants’ motion to dismiss. First, the entire fairness standard did not apply because there was no conflict between the controlling stockholder and the minority. The controlling stockholder allowed the minority to share ratably in the control premium paid by the acquiror, with all stockholders having equal claim to the same consideration. Second, the case was not governed by Revlon, because the merger consideration consisted of a mix of 65 percent stock and 35 percent cash, with the stock portion being stock in a company whose shares were held in a large, fluid market.

j. In re Encore Energy Partners LP Unitholder Litigation, C.A. No. 6347-VCP, 2012 WL 3792997 (Del. Ch. Aug. 31, 2012)

Plaintiff unitholders filed a lawsuit against a limited partnership challenging a merger with the indirect parent of the partnership’s general partner, claiming that defendants had breached their contractual and fiduciary duties by approving the merger. Relying on the express provisions of the limited partnership agreement, the court granted defendants’ motion to dismiss the claims with prejudice. First, the court found that the limited partnership agreement required plaintiffs to plead facts showing that defendant conflicts committee members acted in bad faith by approving the merger with the subjective belief that it was not in the partnership’s best interests. The court concluded that although the conflicts committee may have run an ineffective negotiation, plaintiffs had not alleged sufficient facts to reasonably infer that the conflicts committee subjectively believed it was acting contrary to the partnership’s interests by approving the merger. Second, the court found that plaintiffs could not demonstrate any breach under the implied covenant of good faith and fair dealing because plaintiffs received the benefit of their bargain under the limited partnership agreement and because defendants were conclusively deemed to have acted in good faith because they relied on the opinion of an independent, competent financial adviser in deciding to approve the merger agreement.

k. Feeley v. NHAOCG, LLC, C.A. No. 7304-VCL, 2012 WL 5949209 (Del. Ch. Nov. 28, 2012)

Plaintiff, manager of an LLC, filed litigation seeking to block a member of the LLC from taking control of the company. The member brought counterclaims alleging that the manager had violated its default fiduciary duties by engaging in willful misconduct. The manager moved to dismiss those counterclaims, arguing that LLCs are creatures of contract and that the managing member of an LLC owes only the duties explicitly stated in the operating agreement. The manager’s motion to dismiss was denied. The court found that default fiduciary duties apply in an LLC context because: (1) numerous Court of Chancery decisions had so held, (2) Chancellor Strine’s dictum in Gatz provided persuasive reasons to apply fiduciary duties in the LLC context

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and (3) the drafting history and a plain reading of the LLC Act confirmed that fiduciary duties apply to LLC managers.

2. Books and Records Inspection

a. Amalgamated Bank v. NetApp, Inc., C.A. No. 6772-VCG, 2012 WL 379908 (Del. Ch. Feb. 6, 2012)

A shareholder who had filed a derivative complaint in California, sought inspection of the corporation’s books and records in Delaware in aid of pleading demand futility in the California action. Following a trial in Delaware, the court ordered the company to produce certain documents to the shareholder. The shareholder claimed that the production was incomplete, and moved to compel. The court denied the motion to compel, holding that a derivative plaintiff’s opportunity to inspect books and records related to that suit is limited to the narrow window in which the derivative plaintiff has been granted leave to amend its complaint. Because plaintiff had filed its second amended derivative complaint in the California action, it no longer had a proper purpose to seek books and records. The court rejected plaintiff’s argument that a proper purpose still existed because it might be able to persuade the California court to grant it another opportunity to amend.

b. Louisiana Municipal Police Employees’ Retirement System v. Lennar Corp., C.A. No. 7313-VCG, 2012 WL 4760881 (Del. Ch. Oct. 5, 2012)

Plaintiff shareholder brought a section 220 books and records demand to investigate possible mismanagement at a company after plaintiff suspected mismanagement with respect to the company’s compliance with labor, tax, and immigration law. The court granted the company’s motion for summary judgment because plaintiff did not demonstrate a “credible basis” for thinking there had been wrongdoing. First, a handful of past lawsuits filed against the company did not form a credible basis to suspect wrongdoing, because all of the suits settled without any admission of wrongdoing and plaintiff gave no indication whether the number of lawsuits brought against the company was unusual. Second, two news articles did not provide a credible basis to infer wrongdoing, because they only suggested the existence of an investigation in which defendant was one of many companies being investigated. Finally, the lawsuits and the articles, considered cumulatively, failed to provide a credible basis to infer wrongdoing because the probative value of each item was so negligible that combining them was of no consequence.

3. Breach of Contract

a. Gerber v. Enterprise Products Holdings, LLC, C.A. No. 5989-VCN, 2012 WL 34442 (Del. Ch. Jan. 06, 2012)

Plaintiff, a unit-holder of a limited partnership, challenged two transactions by the limited partnership, alleging breaches of express and implied duties under the limited partnership agreement (LPA). In 2009, the limited partnership sold an LLC to an affiliate. In 2010, that same limited partnership agreed to merge with the affiliate. Because both the 2009 sale and the 2010 merger represented potential conflicts of interest, the transactions were approved by the limited partnership’s Audit, Conflict, and Governance Committee in compliance with the Special

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Approval terms of the LPA. An investment bank provided fairness opinions with respect to both transactions. The court ruled that the limited partnership did not breach its express duties under the contract because its board complied with the Special Approval process delineated in the LPA. Also, the board did not breach its implied duties of good faith by choosing to use the Special Approval process because the board relied upon fairness opinions from the investment bank. Under the LPA, actions taken in reliance upon such opinions were conclusively presumed to have been taken in good faith.

b. Martin Marietta Materials, Inc. v. Vulcan Materials Co., C.A. 7102-CS, 2012 Del. Ch. LEXIS 93 (Del. Ch. May 4, 2012)

In 2010, a target and an acquiror were discussing a potential business combination. The two entities entered into confidentiality agreements in the interest of keeping their discussions confidential. In 2011, after discussions stalled, the acquiror launched a hostile exchange offer in which it sought to purchase all of the target’s outstanding shares. That same day, the acquiror brought suit to obtain a declaration that nothing in the confidentiality agreements barred its hostile bid. The target sought to enjoin the exchange offer, and filed counterclaims alleging that the acquiror breached its contractual obligations under the agreements by improperly using and disclosing confidential information. The court ruled that the acquiror breached the confidentiality agreements, and enjoined the acquiror for a period of four months from taking steps to acquire control of the target’s shares or assets. First, the acquiror improperly used confidential information to formulate a hostile rather than a friendly bid, which is all that was contemplated by the parties’ agreements. Second, the acquiror improperly disclosed confidential information in SEC filings. Finally, even assuming the information it filed with the SEC was “legally required,” the acquiror: (1) failed to comply with the notice and vetting process outlined in the agreements, (2) made disclosures that exceeded the scope of what was legally required and (3) made impermissible disclosures to investors and the media.

4. Fraudulent Misrepresentation

a. RAA Management, LLC v. Savage Sports Holdings, Inc., No. 577, 2011, 2012 Del LEXIS 271 (Del. May 18, 2012)

A potential bidder brought a suit for fraudulent misrepresentations against a target company after negotiations failed. During negotiations, the two companies entered into a nondisclosure agreement (NDA) that explicitly provided that the target made no representations or warranties as to the accuracy or completeness of any information being provided to the bidder, and precluded liability against the target for bidder’s reliance on such information. The bidder, however, alleged that the target intentionally misrepresented the extent of certain liabilities against the target at the outset of discussion, and that the NDA executed between the two parties did not cover intentional misrepresentations. The Delaware Supreme Court affirmed the lower court’s dismissal of the case, finding: (1) the language of the contract was unambiguous, and the target could not be liable for intentional or fraudulent misrepresentations; (2) the “peculiar-knowledge” exception was inapplicable because the bidder was a sophisticated party that could have negotiated to include the appropriate assurances and (3) allowing the case to proceed would essentially negate such disclaimers because — at the pleading stage — prior oral assurances would trump even the most explicit disclaimer in a negotiation agreement.

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5. Entire Fairness

a. Keyser v. Curtis, C.A. No. 7109-VCN, 2012 Del. Ch. LEXIS 175 (Del. Ch. July 31, 2012)

Plaintiff shareholders sought a declaration that a director’s issuance of super-voting shares to himself to maintain control of the company was invalid. In late 2010, the sole director of the company learned of a shareholder’s plan to exercise an option that would give the shareholder and his affiliates control of the company. Defendant, in his capacity as the sole director, caused the company to issue him 25,000 shares of Series B preferred stock priced at a penny per share, which provided him with: (1) majority control of the company, (2) a $1.00 per share liquidation preference and (3) an option to redeem the shares at any time for $1.00 per share. The court declined to review the case under the Blasius standard — the standard typically used to review actions interfering with the shareholder franchise — because the Series B issuance was a self-dealing transaction, and therefore warranted entire fairness review. The court determined that the issuance was not entirely fair, and therefore deemed the issuance invalid.

6. Demand Futility

a. South v. Baker, C.A. No. 7294-VCL, 2012 WL 4372538 (Del. Ch. Sept. 25, 2012)

Plaintiff shareholder brought a derivative suit after a mining company issued a press release lowering its projections for silver production, a government regulator issued a press release noting that the company had been cited for numerous safety violations and related securities class action suits were filed. Plaintiff did not make a Section 220 Books and Records request prior to filing. The court found that plaintiff failed to sufficiently plead demand futility. Specifically, plaintiff failed to plead that: (1) the board was knowingly involved in decisions that violated positive law because the complaint did not “cite any statute, regulation, or other provision of positive law that the [b]oard allegedly decided consciously to violate”; (2) the board consciously failed to act after learning about evidence of illegality (the proverbial “red flag”) because the complaint failed to allege that the directors were told about supposed “red flags” and failed to describe the board’s response to such information and (3) there was “a systematic failure of the board to exercise oversight” because complaint discussed the fact that the board had created a safety committee charged with oversight responsibility and composed of the four outside directors with the most mining industry experience. Thus, the complaint itself refuted the assertion that the directors utterly failed to attempt to fulfill their oversight obligations. Finally, because plaintiff filed hastily without a deliberate and thorough pre-suit investigation, the court applied a mandatory “evidentiary presumption” that plaintiff had acted disloyally and was not an adequate fiduciary representative for the corporation. The court dismissed the case with prejudice to the named plaintiff only, and stated that the 23.1 dismissal should not have preclusive effect on subsequent shareholder actions based upon the same facts and circumstances.

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7. Action to Compel a Meeting of Stockholders

a. Rich v. Fuqi International, Inc., C.A. No. 5653-VCG, 2012 WL 5392162 (Del. Ch. Nov. 5, 2012)

Plaintiff shareholder brought an action to compel a meeting of a company’s shareholders because the company had not held a meeting in over 13 months. The company argued that it had not held its annual meeting because it was unable to provide audited financial statements for the prior fiscal year or later, and that it would therefore violate SEC rules to hold the annual meeting or solicit proxies from shareholders. During litigation, the company asked the SEC for an exemption from the relevant proxy rules. The request, however, was later withdrawn on account of informal communications from the SEC indicating the application would likely be denied. Following this withdrawal, the court ordered the company to hold its annual meeting. The company moved for entry of partial final judgment under Rule 54(b) and, in the alternative, moved for certification for interlocutory appeal. The court denied both motions, and determined that prior precedent — Newcastle Partners — required the company to hold its annual meeting. The court noted that, in choosing to withdraw its SEC exemption request, the company had made a tactical decision and should be prepared to accept the consequences of its choice, and also that it “cannot be the case that managers of a corporation can entirely avoid the annual meeting requirement by dickering with the auditors and the SEC over financial statements.”

8. Action for Advancement of Legal Fees and Expenses

a. Miller v. Palladium Industries, Inc., C.A. No. 7475-VCN, 2012 WL 6740254 (Del. Ch. Dec. 31, 2012)

Plaintiff, director and CEO of a company, brought a suit against the company for advancement of legal fees and expenses under 8 Del. C. § 145(e) after the company sued him for breaches of fiduciary duty. The company moved for judgment on the pleadings, arguing that the company’s bylaws — which provided that fees “shall be paid by the corporation in advance of such proceeding’s final disposition unless otherwise determined by the Board of Directors in the specific case” — did not require advancement of fees. The court granted the company’s motion for judgment on the pleadings, holding that that the only reasonable reading of the bylaws was that Palladium must advance legal fees and expenses if the board does not adopt a contrary directive. Because the board had considered plaintiff’s request for advancement, voted to deny it, and based this decision on multiple independent reasons, plaintiff was not entitled to advancement under the company’s bylaws.

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XII. SEC RULES AND GUIDANCE


The SEC issued several new regulations in 2012, and many of them stem from the 2010 Dodd-Frank Act. Among other changes, the SEC tightened its rule on investment advisory performance, exempted certain swap-based transactions from some provisions of the Securities Act, adopted important definitions of “security-based swap dealer” and “major swap participant,” required exchanges to adopt standards on compensation, and adopted procedures to review security-based swaps that go through clearing agencies.

B. NOTEWORTHY RULES AND GUIDANCE ISSUED BY THE SEC DURING 2012

1. SEC Modifies “Neither Admit Nor Deny” Policy

On January 8, 2012, the SEC’s Enforcement Division announced that it would not allow defendants who have been convicted of criminal wrongdoing to simultaneously deny liability in SEC settlements. This approach slightly modifies the SEC’s prior “neither admit nor deny” policy.

2. SEC Designates BATS Securities as Covered Securities

On January 20, 2012, the SEC adopted a rule designating securities listed, or authorized for listing, on Tiers I and II of BATS Exchange, Inc. (BATS) as “covered securities” under Section 18(b)(1) of the Securities Act. Under Section 18(a) of the Securities Act, covered securities on BATS are exempted from the registration requirements of state “Blue Sky” laws. But covered securities must still comply with applicable listing standards, federal securities laws and federal rules and regulations regarding the registration and sale of securities.

3. SEC Tightens Rule on Advisory Performance Fee Charges

On February 15, 2012, the SEC revised the rule regarding performance fees that investment advisors may charge to investors by raising the net worth and asset threshold of “qualified clients.” To be deemed a qualified client, an investor must meet a net worth or asset threshold, which the SEC deems necessary to be able to bear the risks associated with performance fee arrangements. Under the revised rule, a qualified client must have at least $1 million in assets under management with the advisor, up from $750,000, or a net worth of at least $2 million, up from $1.5 million. Every five years, the SEC will issue an order making inflation adjustments to these dollar thresholds. Furthermore, the rule excludes the value of the client’s primary residence and certain property-related debts from the net worth calculation. This exclusion was not required by the Dodd-Frank Act, but is consistent with the SEC’s determination of net worth for an “accredited investor,” which was adopted on December 21, 2011. The revised rule also has a grandfather provision, under which a registered investment advisor may continue charging clients performance fees if the client was deemed a “qualified client” prior to the rule changes. Newly registered investment advisors may also continue charging performance fees to those clients who were already paying performance fees.

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4. SEC Adopts Exemptions for Security-Based Swaps

On March 30, 2012, the SEC adopted a rule exempting certain security-based swap transactions from provisions of the Securities Act — with the exception of the anti-fraud rules in Section 17(a) and the registration requirements of the Exchange Act — provided several criteria are met. To qualify for the exemption, the swap transaction must be: (1) entered into through a clearing agency, which acts as a central counterparty for the swap-based transaction, (2) registered with a data repository for swap transactions and (3) executed on an exchange or security-based swap execution facility if it is subject to a mandatory clearing requirement by the SEC.

5. SEC and CFTC Adopt Rules Defining “Security-Based Swap Dealer” and “Major Swap Participant”

On April 18, 2012, the SEC adopted new rules to define “swap dealer” and “major swap participant” under the Exchange Act, establishing which entities involved in the swaps market are subject to the regulatory regime created by the Dodd-Frank Act. The rules were written jointly by the SEC and the US Commodity Futures Trading Commission (CFTC).

The rules define a “security-based swap dealer” as a person who: (1) holds himself out as a dealer in security-based swaps, (2) makes a market in security-based swaps, (3) regularly enters into security-based swaps with counterparties as an ordinary course of business for his own account or (4) engages in activity causing him to be commonly known in the trade as a dealer or market maker in security-based swaps. This definition does not include a person who enters into security-based swaps for his own account, but not as a part of his regular business. Additionally, the regulation exempts persons who engage in a de minimis quantity of security-based swap dealing at an aggregate gross notional amount of no more than $3 billion over the preceding 12 months. This de minimis threshold will be phased in over a three-year period, during which time the threshold will be, effectively, $8 billion.

The new rules define “major swap participant” as: (1) a person whose outstanding security-based swaps create “substantial counterparty exposure” that could have serious adverse effects on the financial stability of the U.S. banking system or financial markets, where “substantial counterparty exposure” is defined as holding $5 billion in daily average uncollateralized outward exposure or $8 billion in daily average uncollateralized exposure plus any potential future exposure or (2) a financial entity that is highly leveraged relative to the amount of capital such entity holds, is not subject to capital requirements established by an appropriate federal banking agency and that maintains a “substantial position” in any of the major security-based swap categories, where “substantial position” means holding (i) a major category of security-based swaps (or $3 billion for rate swaps); or (ii) a daily average uncollateralized outward exposure plus potential future exposure of $2 billion in major security-based swaps (or $6 billion for rate swaps) across all categories of swaps or (iii) a person who maintains a “substantial position” in any of the major security-based swap categories, excluding positions held for “hedging or mitigating commercial risk.”

Under the Commodity Exchange Act (CEA), a person who is not an eligible contract participant cannot enter into a swap except subject to the rules of a designated contract market.

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The new rules provide parallel definitions of “swap dealer” and “major swap participant” in the CEA and add swap dealers and major swap participants to the list of entities that are eligible contract participants.

6. CFTC Adopts Reporting Rule for Pre-Dodd-Frank Swap Transactions

On May 18, 2012, the CFTC passed a rule governing how banks and other companies are required to report swap transactions entered into prior to the enactment of the Dodd-Frank Act rules on derivatives trading. The CFTC rule requires swap counterparties for swaps entered into on or after April 25, 2011 to report the primary economic terms for swaps and any confirmation, master agreement or credit support agreements that are part of the swap. Swap dealers or major participants must keep these documents in electronic form, unless they were maintained exclusively in paper form. If the swap expired prior to the release of the draft version of the CFTC’s rule, the swap counterparties are required to keep all records, but may do so in either paper or electronic form.

7. SEC Adopts Rule Requiring Exchanges to Adopt Listing Standards on Compensation

On June 20, 2012, the SEC adopted a rule directing national securities exchanges to adopt listing standards for boards of directors and compensation advisors of publicly listed companies. Once these listing standards are in effect for an exchange, a listed company must meet those standards to continue trading its shares on that exchange. In accordance with the rule, exchanges proposed listing standards by September 25, 2012. Final listing standards must be submitted to the SEC by June 27, 2013.

First, the new rule requires exchanges to adopt listing standards to ensure that each member of the company’s compensation committee is a member of the board of directors and is independent. The definition of “independent” depends on several relevant factors, including: (1) the source of compensation for that member and (2) whether the member of the board of directors is affiliated with the company or a subsidiary.

Second, the new rule requires the listing standards to provide that the compensation committee of a listed company: (1) may retain a compensation adviser, (2) is responsible for the oversight of compensation advisors and (3) must be properly funded by the listed company.

Third, the new rule requires listing standards providing that a compensation committee may select a compensation consultant, legal counsel or other advisor (excluding in-house legal counsel) only after considering six independent factors: (1) whether the compensation consulting company is providing any other services to the company, (2) how much the compensation consulting company receives in fees for the consultant as a percentage of that person’s total revenue, (3) the nature of the compensation consulting company’s internal policies regarding conflicts of interest, (4) whether the consultant has business or personal relationships with a member of the compensation committee, (5) whether the consultant owns any stock of the company and (6) whether the compensation consulting company or consultant has any business or personal relationship with an executive of the issuer.

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Finally, the new rule exempts the following categories of companies from the compensation committee independence requirements: (1) limited partnerships, (2) companies in bankruptcy proceedings, (3) open-ended management investment companies registered under the Investment Company Act of 1940 and (4) certain foreign private issuers.

8. SEC Adopts Dodd-Frank Act Procedures to Review Clearing Submissions

On June 28, 2012, the SEC adopted rules establishing procedures for the SEC’s review of security-based swaps that clearing agencies plan to accept for clearing. The Dodd-Frank Act requires certain security-based swap transactions to be cleared through a clearing agency, which assumes the risk of a default. Under the new rules, a clearing agency will be required to electronically file qualitative and quantitative information with the SEC regarding any security-based swap that the clearing agency is planning on accepting for clearing. The clearing agency must also post these filings on their websites within two business days.

Additionally, the new rules govern when a “systemically important” clearing agency, i.e., an agency whose failure would create significant liquidity or credit problems among US financial markets, must provide advance notices to the SEC prior to making changes to its rules, procedures or operations. Broadly, the SEC rule requires advance notice when the clearing agency proposes changes that affect: (1) the risk management functions performed by the clearing agency or (2) the clearing agency’s ability to perform its core clearance and settlement functions. These advance notices describe the nature of the change and how the clearing agency plans to manage any identified risks from the change. Changes that do not require advance notice are, generally, those that are related solely administrative functions of the clearing agency.

9. SEC and CFTC Adopt Final Rules of Key Definitions Regarding Financial Instruments

On July 18, 2012, the SEC and CFTC adopted joint rules defining which financial instruments fall under the definition of a “swap,” “security-based swaps,” “security-based swap agreement” and “mixed swaps.” Under these definitions a “swap” is defined under the CEA and falls under the jurisdiction of the CFTC, a “security-based swap” is defined under the Exchange Act and falls under the jurisdiction of the SEC and “mixed swaps” fall under the jurisdiction of both agencies. The CFTC has regulatory authority over “security-based swap agreements,” but the SEC retains antifraud and other authority over these types of agreements.

The rules define a “swap” as any agreement, contract or transaction that “provides for any purchase, sale, payment or delivery (other than a dividend on an equity security) that is dependent on the occurrence, nonoccurrence, or the extent of the occurrence of an event or contingency associated with a potential financial, economic, or commercial consequence.” This definition includes: (i) cross currency swaps; (ii) currency options, foreign currency options, foreign exchange options and foreign exchange rate options; (iii) foreign exchange rate forwards; (iv) foreign exchange swaps; (v) forward rate agreements and (vi) non-deliverable forwards involving foreign exchange. The rules further define a “security-based swap” as a swap or other financial instrument that is based on: (i) a single security, (ii) futures on a single security, (iii) a single loan or (iv) a narrow-based security index.

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The agencies have excluded from the definitions of “swap” and “security-based swap” products that are historically treated as insurance products and forward contracts regarding non-financial commodities or security for deferred shipment or delivery. Furthermore, loan participations are excluded from the definition of “swap” and “security-based swap” based on the facts and circumstances of the loan participation, including whether the participation: (i) is defined as a security under federal securities laws or (ii) reflects an ownership interest in the underlying loan or commitment.

The rules define a “mixed swap” as a security-based swap that is also based on the value of one or more interest or other rates or instruments that fall under the definition of a “swap,” so that it is both a security-based swap and a swap. For instance, this definition includes instruments in which the underlying reference would be a portfolio of securities and commodities.

The rules define a “security-based swap agreement” as a swap agreement in which “a material term is based on the price, yield, value or volatility of any security or any group or index of securities,” but does not include a security-based swap.

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XIII. DEVELOPMENTS WITH THE PUBLIC COMPANY ACCOUNTING OVERSIGHT BOARD DURING 2012


The Public Company Accounting Oversight Board (PCAOB) issued two notable releases and concluded one notable disciplinary proceeding during 2012. The PCAOB announced that it has entered into cooperative agreements with both the German and Spanish audit regulators, adding to the existing agreements that it has with several other European regulators.1 The PCAOB also adopted, and the Securities and Exchange Commission (SEC) approved, the new Auditing Standard No. 16, along with amendments to other standards, designed to enhance communication between auditors and audit committees. The PCAOB also brought disciplinary proceedings against a Big Four audit firm and several of its current and former partners, in connection with audits of Medicis Pharmaceutical Corporation. The $2 million civil money penalty imposed on the auditor in that action is the largest issued by the PCAOB to date.

B. NOTABLE RELEASES DURING 2012

1. PCAOB Enters into Cooperative Agreements with the German and Spanish Audit Regulators

On April 13, 2012 and July 19, 2012 respectively, the PCAOB entered into separate cooperative agreements with the German Auditor Oversight Commission (AOC) and the Accounting and Auditing Institute of Spain (ICAC) relating to the oversight of audit firms subject to the regulatory jurisdictions of either the AOC or ICAC, and the PCAOB. In addition to providing a framework for conducting joint inspections, these arrangements also include provisions governing the exchange of confidential information between the PCAOB and AOC or ICAC as applicable, as well as agreements on data protection.

2. PCAOB Adopts Auditing Standard No. 16, Communications with Audit Committees, and Amendments to Other Standards

On August 15, 2012, the PCAOB adopted Auditing Standard No. 16, Communications with Audit Committees, and amendments to other PCAOB standards. Auditing Standard No. 16 establishes requirements designed to enhance the relevance and timeliness of communications between the auditor and audit committee and is intended to promote dialogue between the two on audit and financial statement matters. Auditing Standard No. 16 supersedes the PCAOB’s interim auditing standards AU § 310, Appointment of the Independent Auditor, and AU § 380, Communication with Audit Committees, and amends other PCAOB standards. Auditing Standard No. 16 was approved by the SEC on December 17, 2012.

1 In addition to these arrangements with the German and Spanish regulators, the PCAOB also has cooperative agreements in four other European countries: the United Kingdom, the Netherlands, Switzerland and Norway.

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C. NOTABLE DISCIPLINARY PROCEEDINGS DURING 2012

1. PCAOB Announces Settled Disciplinary Orders for Audit Failures Against a Big Four Audit Firm and Four of its Partners

In a February 8, 2012 order, the PCAOB censured a Big Four audit firm, imposing a $2 million civil penalty and sanctioning four of its current and former partners for violating PCAOB rules and standards. The $2 million penalty is the PCAOB’s largest civil money penalty to date. The order related to three audits of Medicis Pharmaceutical Corporation, and a consultation stemming from an internal audit quality review of one of these audits. During the audit periods in question, the auditors failed to comply with PCAOB standards in evaluating Medicis’ practice of reserving for most of its estimated product returns at the cost of replacing the product, instead of at gross sales price, when the auditors knew or should have known that this practice was not supported by evidence. The PCAOB also found that the audit firm and the partners involved violated PCAOB standards in auditing Medicis’ new methodology for calculating year-end product returns reserve estimates for 2006 and 2007, and that an internal review was faulted. The respondents agreed to settle without admitting or denying the PCAOB’s findings.

Documents

2012 Year-End Securities Law Compendium - Latham & Watkins