2015: Selected Judicial Developments In Securities Litigation

Published for the 43rd Annual Securities Regulatory Institute, San Diego, CA January 25-27, 2016


2015 was an eventful year for federal securities litigation. We report on the year's judicial highlights, focusing on appellate decisions addressing the elements of a securities fraud claim.

A.  Omnicare: pleading falsity of opinions

The Supreme Court decision

In March, the Supreme Court issued its eagerly anticipated decision in Omnicare, Inc. v. Laborers Dist. Council Constr. Industry Pension Fund, __ U.S. __, 135 S. Ct. 1318 (Mar. 24, 2015). Omnicare reversed the denial of a motion to dismiss a Securities Act Section 11 lawsuit challenging a healthcare services provider's statements that it complied with applicable law. The decision is significant at the outset because the Court recognized a distinction between statements of opinion and belief and statements of fact. For the statements of opinion at issue in the case, the Court agreed with the defense that the only fact expressed in such a statement is that the speaker genuinely believed it, and hence that falsity may be pleaded only if facts are alleged showing that the speaker did not believe it (a position plaintiffs had eschewed).

However, the Court agreed with plaintiffs that liability could also exist under the omissions clause of the Section 11 statute. If a statement of opinion omits material facts about the issuer's inquiry into, or knowledge concerning, a statement of opinion, and if those facts conflict with what a reasonable investor would infer from the statement itself, the omissions clause creates liability. The linchpin of this analysis is the premise that investors bring to a registration statement reading table expectations about how opinions are formed and that there are no contradictory undisclosed facts. The Court also drew from the common law principle that a party with superior knowledge of the topic of its opinion is understood to have drawn upon that knowledge in expressing an opinion; in this context, issuers have special knowledge of the topic of an opinion statement concerning its business. Hence, the type of facts a Section 11 plaintiff must plead to state a claim based on an opinion under the omissions clause are either material facts indicating that there was not the basis for the statement of opinion that a reasonable investor would have expected the speaker to have, or material facts known to the speaker than contradicted (not just questioned or disagreed with) its stated opinion. Falsity cannot be pleaded by conclusory assertions; a complaint must "identify particular (and material) facts going to the basis for the issuer's opinion . . . whose omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context." This would be "no small task for an investor," even under the Rule 8(a) standard that applied in the case (as the plaintiffs had disclaimed any allegations of fraud).

Application: the distinction between statements of fact and statements of opinion

Subsequent courts have drawn upon many aspects of Omnicare, starting with its distinction between opinion and fact statements. Nakkhumpun v. Taylor, 782 F.3d 1142 (10th Cir. 2015), affirmed in part the dismissal of a lawsuit alleging that an oil company misrepresented a proposed sale of a large stake in the company's core assets, and its financial condition. One challenged statement was an opinion on the company's "financial situation," and under Omnicare plaintiffs were required but failed to allege facts that cast doubt on the speaker's belief in the truth of the statement. Special Situations Fund III QP, L.P. v. Deloitte Touche Tohmatsu CPA, Ltd., No. 13 Civ. 1094 (ER), 2015 BL 92150 (S.D.N.Y. Mar. 31, 2015), denied a motion for leave to file a second amended complaint, and dismissed the claim alleged against auditors with prejudice, because both the existing and proposed complaints did not plead facts showing the falsity of the auditors' opinions under a subjective disbelief standard. The court quoted Omnicare for the proposition that a sincere statement of pure opinion is not an untrue statement of material fact regardless of whether an investor ultimately can prove the belief was wrong.

Applying the same distinction but to a different result, In re Petrobas Sec. Litig., No. 14-cv-9662 (JSR), 2015 BL 243537 (S.D.N.Y. July 30, 2015), denied in large part a motion to dismiss a lawsuit alleging that the Brazilian state-owned oil company engaged in a bribery and kickback scheme in which a cartel of suppliers conspired to win construction bids from the company, because the allegations sufficed to plead that the company did not believe some of its opinion statements, per Omnicare standards.

Application: falsity under the omissions prong

Other decisions found that falsity was not pleaded under the omissions prong of Omnicare. One week after the Supreme Court's decision, Corban v. Sarepta Therapeutics, Inc., No. 14-cv-10201-IT, 2015 WL 1505693 (D. Mass. Mar. 31, 2015), dismissed a complaint alleging that a pharmaceutical company misrepresented clinical trial and FDA approval status of a drug under development. Many of the challenged statements were interpretations of the clinical trial data, which the court found to be non-actionable opinions, given the lack of allegations that defendants did not believe them or lacked the type of reasonable basis an investor would expect per Omnicare. Lipow v. Net 1 UEPS Technologies, Inc., __ F. Supp. 3d __, No. 13 Civ. 9100 (ER), 2015 WL5459730 (S.D.N.Y. Sept. 16, 2015), held that a statement that a company believed that it had won a government contract in accordance with the law was an opinion, and the complaint did not plead that the company was aware of or participated in the alleged wrongdoing that would mean that its opinion lacked a basis in fact, as Omnicare requires.

In re Ocwen Financial Corp. Sec. Litig., No. 14-81057 CIV-WPD (S.D. Fla. Sept. 4, 2015), dismissed a lawsuit alleging that a mortgage servicing company misrepresented its intention to integrate the systems of companies it had acquired. Many of the challenged statements were opinions, but the complaint did not allege they were not genuinely believed or that they were rendered misleading by omission of facts about their basis, as required by Omnicare. Southeastern Pennsylvania Transportation Authority v. Orrstown Financial Services, Inc., No. 1:12-cv-00993, 2015 BL 438300 (M.D. Pa. June 22, 2015), dismissed a lawsuit filed after a community bank reported internal control deficiencies and poor results. The court noted that Omnicare had explained that a statement of opinion does not express certainty about a matter. The bank's statements about its underwriting practices describing them as stringent, sound, conservative, "high quality" and the like were opinions under Omnicare because they were non-specific puffery. The auditors' opinions also were encompassed by Omnicare, and the court reasoned that the naked allegation that the opinion lacked a reasonable basis failed to satisfy Omnicare's omissions prong.

Perhaps the most interesting decision on this point is City of Westmoreland Police & Fire Retirement Sys. v. MetLife, Inc., No. 12-cv-0256 (LAK), 2015 WL 5311196 (S.D.N.Y. Sept. 11, 2015), because the court had paused in deciding a pending motion to dismiss until Omnicare was decided and then explained that Omnicare had made it more difficult to plead falsity with respect to opinions. The plaintiffs alleged that the defendant insurance company failed to record the proper amount of reserves for incurred but not reported ("IBNR") death benefit claims for group life insurance policies. The court noted that Omnicare, while a Section 11 case, applied with equal force to Section 10(b) and Rule 10b-5, "which uses very similar language." Omnicare made clear that "it is substantially more difficult for a securities plaintiff to allege adequately (or, ultimately, to prove) that such a statement [of opinion or belief] is false than it is to allege adequately (or ultimately prove) that a statement of pure fact is false." Under Omnicare, "the plaintiff must identify particular (and material facts) going to the basis of the issuer's opinion-facts about the inquiry the issuers did or did not conduct or knowledge it did or did not have-whose omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context." Thus, while the court had held in an earlier decision that plaintiff had pleaded falsity by alleging that the increase in IBNR reserves proved to be insufficient once the company had cross-checked a new source of information, Omnicare now required more to plead the falsity of the statement because it was a statement of opinion.

That being said, some courts found it possible to plead falsity under Omnicare's omissions prong. In re Genworth Financial Inc. Sec. Litig., No. 3:14-CV-682, 2015 BL 127868 (E.D. Va. May 1, 2015), denied in part a motion to dismiss a lawsuit alleging that an insurance company understated reserves and misrepresented the profitability of its core business. The court stated that falsity was pleaded under an "alternative Omnicare analysis." Certain statements at issue were not necessarily opinions because they did not use the words "believe" or "think," but assuming they were opinions, falsity was pleaded on the theory that the defendants did not disclose that the company had not actually engaged in the deep review of the data it said it had undertaken and had used outdated data in coming to its opinion. In re Bioscrip, Inc. Sec. Litig., ___ F. Supp. 3d ___, No. 13-cv-6922 (AJN), 2015 WL 1501620 (S.D.N.Y. Mar. 31, 2015), denied in part a motion to dismiss a lawsuit alleging that a home healthcare services company failed to disclose a potential government anti-kickback probe involving an iron chelation drug, which later evolved into a lawsuit and a settlement. The court construed Omnicare to allow liability if there were undisclosed facts that "would likely conflict with a reasonable investor's own understanding of the facts conveyed by that statement." Subjective and objective falsity was pleaded under the interesting theory that the government inquiry "informed the Defendants as to what conduct was being investigated by the Government...and at the very least allows for the inference that the Defendants did not actually believe the compliance statement." According to the court, a reader plausibly would have taken the legal compliance statements to mean that the company had taken an appropriate internal review of compliance procedures and possible legal liabilities, but the government subpoena "presented a major compliance challenge...." The court also opined that even if a scrupulous review of the matter had been performed, a reasonable investor would find a contradiction between a supposed carte blanche conclusion of no liability from the company's affirmative statements and the significant challenge posed by the subpoena.

Application: finding a reasonable basis for an opinion

Two other decisions in 2015 adopted one of the points the authors made in an article discussing the anticipated Omnicare decision for last year's SRI conference. We wrote that if Omnicare adopted the standard that a statement of opinion is not false so long as any reasonable basis for it existed, this would make it difficult for plaintiffs to challenge statements of opinion because the law and logic are replete with reasonable bases for the typical kinds of opinions stated by issuers. Omnicare did not adopt this precise standard-the Court wrote about the type of reasonable basis that would be expected for a particular statement-but the final decision was close enough to the authors' forecast of an "any reasonable basis" standard that such a standard has come into play in certain cases applying Omnicare. Battle Construction Co. v. InVivo Therapeutics Holding Corp., No. 14-13180-RGS, 2015 BL 96182 (D. Mass. Apr. 3, 2015), dismissed a complaint alleging that a biotechnology company misrepresented the conditions the FDA had placed in approving a clinical trial for a small number of patients of a spinal injury repair product in development, and the estimated time to complete the trial. Among other points, the court noted that the FDA approval letters known to the company at the time of the challenged statements had stated that the process "will result in a total of 5 subject[s] enrolled over a minimum 15 month period." This meant that the forecast for the time to complete the trial was not unrealistic or implausible, as plaintiffs alleged; a reasonable basis for a forecast can come from information provided by a government agency. The court cited Omnicare for the proposition that a sincere statement of pure opinion is not an untrue statement of material fact even if an investor can ultimately prove it wrong. In re Hertz Global Holdings, Inc. Sec. Litig., No. 13-7050, 2015 BL 4469143 (D. N.J. July 22, 2015), dismissed a complaint alleging, inter alia, that a rental car company had failed to incorporate the effect of a federal budget sequestration into its public forecasts. The complaint did not allege that an internal analysis of the sequestration alleged in the complaint had not already been taken into account in the public forecasts, and other reasonable bases may have existed for the forecast.

B. Scienter and Antiscienter

The majority of published appellate decisions in 2015 addressing scienter held that the respective complaints did not plead the strong inference of scienter required by the Private Securities Litigation Reform Act. Most of these decisions found not only that the complaints lacked sufficient scienter allegations, but that there were allegations or matters of judicial notice that counseled against a finding of scienter and that must be considered under Tellabs.

Appellate decisions holding that scienter was not pleaded

In re ZAGG, Inc. Sec. Litig., 797 F.3d 1194 (10th Cir. 2015), affirmed the dismissal of a lawsuit alleging that a protective covering company failed to disclose that its CEO had pledged nearly half his shares as collateral in a margin account. The pledge is "very much legal," but must be disclosed under Regulation S-K Item 403(b). The complaint did not plead scienter because it did not allege that the CEO intended to deceive investors or was reckless. A Form 144 had disclosed the margin call and the pledge was legal, and the CEO did not have a reason to think that the margin account was something to hide. The conceded fact that Item 403(b) was not complied with also did not plead scienter, assuming (as was not alleged) that the CEO had read the relevant proxy statement. It was plausible that the CEO would have a motive to hide the pledge, as the disclosure "may cause a drop in share price," but this was not enough to make up for the deficiencies in plaintiffs' other factual allegations, and in fact the CEO had disclosed the margin account. Another anti-scienter inference was that the CEO simply did not know about the relevant aspect of Item 403(b).

Podraza v. Whiting, 790 F.3d 828 (8th Cir. 2015), affirmed the dismissal of a lawsuit filed after a now-bankrupt coal company issued a restatement to change its method of accounting for remediation measures at mines it had acquired. The complaint did not allege specific facts showing defendants knew they should have expensed the costs for the remediation efforts or were reckless in not doing so, which plaintiffs claimed was required by GAAP. Moreover, any inference of scienter was "contradicted" by the auditors' opinion in favor of the accounting and the company's thorough (if ultimately incorrect) explanation of its accounting decisions to the SEC. The fact that the SEC notified the company of the issue counseled against inferring scienter due to timing considerations. The SEC had not spoken for almost a year after raising the issue, and when it later suggested that the company should restate (not that it had to do so), the company followed this advice one month later.

Owens v. Jastrow, 789 F.3d 529 (5th Cir. 2015), affirmed the dismissal of a lawsuit alleging that the officers of a failed bank holding company failed to timely write down the value of mortgage-backed securities in its portfolio. While the complaint alleged that three defendants knew that the bank needed additional capital, this motive was not so crucial as to the bank's continuing operation to constitute a particularly strong scienter allegation; here, the court noted that securities in question were only 22% of the portfolio's assets. Significantly, the court explained that disclosed adverse facts could not constitute "red flags," and the underlying facts about the portfolio were included in public filings that investors could assess as they saw fit. Such disclosure "negates the inference that defendants acted with scienter," as did "[a]dditional transparency" from the defendants as to the nature, inputs, and essential contingencies of its internal valuation models.

Brophy v. Jiangbo Pharmaceuticals, Inc., 781 F.3d 1296 (11th Cir. 2015), affirmed the dismissal of a former CFO and auditors from a lawsuit alleging that a China-based pharmaceutical and supplements company issued false financial statements and misrepresented its liquidity. There were no particularized factual allegations that directly showed that the CFO intended to deceive investors or was severely reckless with respect to deficiencies in reporting. Rather, plaintiffs' theory essentially was that she must have been aware due to her position as the CFO of a company plagued with serious cash balance fraud, an SEC investigation, and internal control weaknesses-but the allegations of the underlying issues were themselves vague, and under Tellabs, omissions and ambiguities in a complaint weaken any inference of scienter. Also weighing against scienter was the allegation that the CFO was a resident of Florida, not China, and the absence of allegations that she sold stock.

In re Advanced Battery Technologies, Inc., ___ F.3d ___, No. 14-1410-cv (2d Cir. 2015), affirmed the denial of a motion for leave to file a second amended complaint, which resulted in dismissal of the auditors in a lawsuit involving a China-based energy company. The auditors had issued opinions that certified that the financial statements conformed with GAAP and presented fairly the company's financial position, and that the audits had been conducted in accordance with PCAOB standards. The court held that the proposed "red flag" allegations did not plead scienter under the standard applicable to auditors, which is an approximation of an actual intent to aid in the fraud being perpetrated by the audited company. None of the accounting standards on which plaintiff relied specifically require an auditor to inquire about or review a company's foreign regulatory filings, and the fact that the China-based client used a reverse merger to access the US securities markets constitute a red flag, as the heightened scrutiny that began to be applied to such companies in mid-2011 did not emerge until after the audits in question. A more compelling inference than auditor recklessness was that the company maintained two sets of data and fed its auditors false data to complete its audits, especially as the complaint alleged that the company had been secretive about its transactions.

Fire & Police Pension Ass'n v. Abiomed, Inc., 778 F.3d 228 (1st Cir. 2015), affirmed the dismissal of a lawsuit alleging that a medical device company misrepresented that its policy was to avoid off-label marketing of its flagship micro heart pump product and that it was cooperating with an FDA inquiry into its marketing tactics. Retired Supreme Court Justice Souter sat on the panel by designation. The court began by stating: "Not all claims of wrongdoing make out a viable claim that the company has committed securities fraud. This case is an example." The court reasoned that the materiality and scienter inquiries are linked in that if it is questionable whether a fact is material or its materiality is marginal, this tends to undercut the argument that a defendant had the requisite intent or was extremely reckless in not disclosing the fact. Thus, scienter was not pleaded as to statements about the company's revenues because the materiality of the impugned omission was marginal at best. Plaintiffs' assertion to the contrary was based on a long chain of largely unsubstantiated inferences. Here, the court noted that it was more likely that the company reduced its forecast at the end of the class period due to the government investigation rather than the discontinuation of prior marketing materials. Scienter also was undercut by the company's explicit warnings that the FDA might disagree with its marketing and that enforcement action would hurt, and by its (voluntary) disclosures of the FDA's concerns once the agency issued a formal warning letter; as the court concluded, "These are not the actions of a company bent on deceiving investors as to their future earnings prospects." Also counseling against scienter was the fact that the company had asked for meetings with the FDA, and that the matter ended up resolved to the FDA's satisfaction.

In re Gold Resource Corp. Sec. Litig., 776 F.3d 1103 (10th Cir. 2015), affirmed the dismissal of a lawsuit alleging that a mining company misrepresented its ability to attain a planned dramatic increase in production by concealing severe production and efficiency problems, and engaged in revenue recognition fraud via an overbilling scheme by inflating the estimates of the ore volume for which a customer would pay. The court rejected plaintiffs' reliance on the allegations that the GAAP provision was simple, the misstatement was large, that the company quickly caved in to the complaining customer in the dispute, and management's Sarbanes-Oxley certifications. Plaintiffs did not take into account other plausible inferences evident from the complaint and documents referenced therein, including the company's statement that the local employees did not immediately tell the USA executives of the discrepancies because they thought the customer was wrong based on 19 months of strong experience in analyzing the provisional invoices. Another plausible anti-scienter inference negating the production increase was that it is not always possible to anticipate what miners will face as they dig deeper into a mine (as the company did here).

To conclude the appellate cases holding that scienter had not been pleaded, Stratte-McClure v. Morgan Stanley, 776 F.3d 94 (2d Cir. 2015), affirmed the dismissal of a lawsuit alleging that a financial institution misrepresented its exposure to the subprime mortgage market in June through November 2007, when it held a massive net long position via proprietary trading purchases of credit default swaps on CDOs (a short position). In a questionable part of the ruling, the court decided that an omission of a known trend required to be disclosed under Regulation S-K Item 303 theoretically could be actionable under §10(b), on the basis that the omission rendered the company's financial statements misleading. The complaint, however, did not allege scienter under a conscious recklessness standard that approximates the actual intent to mislead investors. The complaint did not allege when employees realized that the more pessimistic assessment of the market were likely to come to fruition and that the company would be unable to reduce the long position. Moreover, the company fully reported its exposure less than a month after its third quarter filing and a month in advance of the next quarterly report. The most cogent inference was that the company delayed releasing information in two 10-Qs to carefully review all the relevant evidence, and was at worst negligent as to the effect of delay on investors.

Appellate decisions holding that scienter was pleaded

A few appellate courts reversed judgments of dismissal upon an evaluation of scienter. Employees' Retirement Sys. of the Government of Virgin Islands v. Blanford, 794 F.3d 297 (2d Cir. 2015), reversed the dismissal of a lawsuit alleging that a specialty prepackaged coffee seller misrepresented that it was straining to meet booming demand when it discussed customer inventory and demand and plans to increase production. Plaintiffs alleged instead that the company was accumulating a significant inventory overstock of expiring and unsold product which it concealed from auditors through phony shipments, according to allegations (some of which were detailed) from anonymous sources from different tiers of the company. The court decided that scienter was pleaded by the intent to deceive auditors, plus the allegation that the company had discouraged questioning about inventory, and because officers sold stock.

Nakkhumpun v. Taylor, cited above, allowed part of a complaint to proceed in a lawsuit alleging that an oil company misrepresented the proposed sale of a large stake in its core assets. The company had stated that the counterparty to the transaction had been unable to obtain financing for the $400 million purchase price, when in fact the counterparty had questioned whether the asset was worth that amount. The district court had reasoned that management had a good reason not to make the disclosure urged by plaintiffs: signaling that a $400 million price remained a valid option would have helped shareholders by maintaining the prospects of obtaining a huge price for the asset. The appellate court decided that this analysis went too far; if the statement was reckless, then even if it was meant to attract other buyers at a high price to the benefit of current shareholders, it also carried the risk of misleading existing and potential shareholders.

To conclude the cases finding that scienter had been pleaded, Zak v. Chelsea Therapeutics Int'l, Ltd., 780 F.3d 597 (4th Cir. 2015), reversed the dismissal of a lawsuit alleging that a pharmaceutical company misrepresented the likelihood of FDA approval for a hypotension remedy under development. The key element of the decision was the court's ruling that it had been improper to take judicial notice of Forms 4 that showed that the key officers had not sold any shares, where the lack of stock sales had been an important element of the district court's scienter analysis. (The court also found that proxy statements offered to show that the officers had increased their holdings did not contain enough information about the number of shares before- and after- the class period to support the proposition for which they had been offered.) The complaint had not alleged stock sales or purported to rely on Forms 4, and hence there was no basis for judicial notice. One may query whether the same proposition (no stock sales) could have been noticed by the court based on the absence of any allegations of stock sales, where Tellabs holds that the absence of allegations one would expect to see in a complaint if there had been fraud is an anti-scienter factor that must be drawn against plaintiffs.

Corporate scienter

In re ChinaCast Education Corp. Sec. Litig., No. 12-57232, ___ F.3d ___ (9th Cir. Oct. 23, 2015), addressed a less-frequently considered aspect of scienter: corporate scienter. The court reversed the dismissal of a lawsuit alleging that the CEO of a China-based educational company looted the company and interfered with an audit while publicly stating that all was fine-misconduct the parties agreed alleged "textbook securities fraud." The district court had declined to impute the CEO's scienter to the corporation under the adverse interest exception. The Ninth Circuit reasoned that as a matter of policy, the adverse interest exception is itself subject to an exception: when a person acts with apparent authority on behalf of a corporation that placed him in a position of trust and confidence and controlled the level of oversight of his handling of the business. The court derived this outcome as a matter of federal common law from agency principles and its 1990 decision in Hollinger v. Titan Capital Corp., which allowed imputation where a fraud is committed within the scope of an agent's employment or where there is apparent or actual authority. One may query how far ChinaCast should be extended. According to the opinion, the company submitted a bare-bones brief on appeal and apologized that it lacked the funds to mount a vigorous appellate defense. A more vigorous defense might lead to different results in a later case; for example, one may argue that Hollinger arose from a unique broker-dealer context in which there are statutory duties of oversight and vicarious liability not present in a standard corporation and that the alleged absence of statutory guidance on issuer liability springs from the fact that Congress did not create a private right of action under Section 10(b) at all, not out of any desire to leave this issue to the courts.

Intent to harm not required

Finally, earlier this month, the Second Circuit addressed scienter in an appeal of a criminal conviction. In United States v. Litvak, No. 14-2902-CR, __ F.3d ___, 2015 WL 8123714 (2d Cir. Dec. 8, 2015), the defendant argued that the "intent to harm" is required for scienter under Section 10(b), as is the case under the mail and wire fraud statutes. The court affirmed the jury's criminal conviction of the defendant on a securities fraud count. Going back to Ernst & Ernst v. Hochfelder, scienter under Section 10(b) requires "a mental state embracing intent to deceive, manipulate or defraud," but the additional intent to harm the counterparty required for mail or wire fraud does not apply. (As noted below, the court reversed the convictions on the other counts.)

C. United States v. Newman

On the enforcement side, courts in 2015 struggled to apply the December 2014 decision in United States v. Newman, 773 F.3d 438 (2d Cir. 2014), which reversed the criminal insider trading convictions of two portfolio managers at two hedge funds who were four to five levels removed from the ultimate sources of material nonpublic information at the issuers whose stocks were traded. Perhaps it is more accurate, however, to state that courts worked to limit Newman or distinguish it on its facts.

Limiting or declining to extend Newman

Securities & Exch. Comm'n v. Payton, 14 Civ. 1644, 2015 BL 96854 (S.D.N.Y. Apr. 6, 2015), denied a motion to dismiss an insider trading lawsuit despite that the court rejected the SEC's argument that Newman should not apply where the information to the remote tippee was obtained by misappropriation, as distinguished from a traditional insider. The court concluded that for purposes of an enforcement action, the "personal benefit" to the tippee required by Newman or SEC v. Dirks had been pleaded under a Rule 9(b) standard. By this formulation, the court suggested that the two standards are different, i.e., that the Second Circuit had misread Dirks and imposed a "more onerous standard of benefit...." United States v. McPhail, No. 14-10201-DJC, 2015 BL 141078 (D. Mass. May 12, 2015), went further in denying a motion to dismiss an insider trading indictment. The court reasoned that personal benefit to the ultimate inside source of the material nonpublic information need not be alleged where the source was an unknowing source in the chain of information, so long as a personal benefit was alleged as to the immediate tipster. The relationship between the source of the information and the tipster need not be fiduciary per se, but rather "fiduciary-like" (such as a close personal history or pattern of sharing confidences).

The same District Court judge who had decided Payton had the opportunity to expand his analysis in United States v. Salman, 792 F.3d 1087 (9th Cir. 2015), where he sat on an appellate panel by designation. In that criminal appeal, there was evidence that the defendant had received nonpublic information from a source who was receiving information from his younger brother, an investment banker (who was engaged to the defendant's sister) with whom he had a close relationship. The court decided that Newman did not change the prior standard for assessing the personal benefit requirement for tippee liability, which supposedly derived from Dirks. Dirks recognized that a breach of fiduciary duty with personal benefit may arise when an insider makes a gift of confidential information to a trading relative or a friend, and that rule controlled here. The court declined to read Newman to hold that evidence of friendship or a familiar relationship was insufficient to demonstrate that the tipper received a personal benefit, to the extent the case could be read to go that far. According to the court, it cannot be the case that an insider can disclose information to her relatives, free for them to trade on it, so long as the insider does not ask for tangible compensation in return, and the defendant in the appeal at bar must have known that the younger brother gave the information with an intention to benefit a close relative.

A sophisticated analysis of Newman was presented in Securities & Exch. Comm'n v. Sabrdaran, No. 14-cv-04825-JSC, 2015 BL 55285 (N.D. Cal. Mar. 2, 2015), which granted in part a motion to dismiss and to strike an insider trading complaint. The tipper defendant challenged the claims supposedly based on the trading of the downstream tippees. The court explained that this was a complex issue. Newman would have been relevant but for the fact that the SEC was not seeking liability based on these downstream trades; it had alleged them only for remedies purposes. Newman did not upset the law holding that an individual liable for insider trading may be on the hook for profits gained by tippees, even where the tippees are not themselves liable for insider trading because they did not have the requisite knowledge.

Refusing attempts to renege on settlements

Two other opinions rejected attempts to renege upon settlements with the SEC after Newman was decided. In Securities & Exch. Comm'n v. Conradt, 309 F.R.D. 186 (S.D.N.Y. 2015), decided by the same judge who adjudicated Payton and Salman, defendants tried to renege after a judge vacated their guilty pleas in a parallel criminal case based on Newman. The court reasoned that the civil settlements were not based on the criminal pleas and Newman had not (and could have) overruled any binding precedent, "nor were the arguments it accepted in any material way novel." A similar entreaty was rejected on the merits in Securities & Exchange Comm'n v. Holley, No. 11-0205 (DEA), 2015 WL 5554788 (D.N.J. Sept. 21, 2015). In that case, the judge reasoned that the defendant tipper had repeatedly acknowledged that he disclosed material nonpublic information for the purpose of benefitting two individuals, one of whom was related to defendant and one with whom he shared a close personal relationship. The defendant's intent to benefit and help people close to him "is precisely the type of personal benefit the Second Circuit referred to in Newman when it stated that a personal benefit may be established by 'evidence of "a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the [latter]."'"

D.  Safe Harbor

Two published appellate decision addressed the Safe Harbor for forward-looking statements. Julianello v. K-V Pharmaceutical Co., 791 F.3d 915 (8th Cir. 2015), affirmed the dismissal of a lawsuit alleging that a pharmaceutical company made misrepresentations regarding the marketing of a drug designed to reduce the risk of pre-term labor. The primary issue with the drug was the extent to which insurers would pay for its price, which initially was $1,500 per injection. The price could in theory be reduced by compounding pharmacists engaged in off-label marketing, which the company warned pharmacists not to do. After controversy erupted over the price, politicians and the FDA fought back, leading to a price reduction. The court affirmed the dismissal on the basis of the Safe Harbor. The statements at issue were forward-looking on several grounds, including that they were statements about plans and objectives for the drug whose veracity could not be determined until after they were made. The statements also could be forward-looking as underlying assumptions for other forward-looking statements. In contrast, In re Harman Int'l Industries, Inc. Sec. Litig., 791 F. 3d 90 (D.C. Cir. 2015), reversed the dismissal of a lawsuit alleging that an audio products company made misrepresentations regarding the sales of a new automobile entertainment system product and a GPS unit. The court decided that the risk factors did not invoke the Safe Harbor for two forward-looking statements because the risk factors failed to account for historical facts about the products that would have been important to a reasonable investor and were "boilerplate."

E.  Puffery

2015 also witnessed developments in the standards for assessing whether a statement is too generalized to support a securities fraud claim-i.e., puffery. More accurately, the developments started in mid-December 2014, when the Ninth Circuit joined other Circuits in holding that the standard for puffery is objective verifiability. In Oregon Public Employees Retirement Fund v. Apollo Group, Inc., 774 F.3d 598 (9th Cir. 2014), the court explained that statements by a company that are capable of objective verification can constitute material misrepresentations. The statements about an education company's growth that plaintiffs challenged, however, were "inherently subjective 'puffing' and would not induce the reliance of a reasonable investor ... These statements are vague and do not set out with specificity the reasons for its enrollment and revenue growth." In contrast, "[t]he cases cited by the Plaintiffs are inapposite because they consider statements that can be true or false on an objective standard, rather than business puffery or opinion."

Subsequently, in 2015, two appellate courts addressed this issue in the context of regulatory actions. United States v. Litvak, noted above, reversed in part the denial of a motion for acquittal or a new trial in a prosecution of a trader alleged to have made false statements about mortgage-backed securities. The evidence was insufficient for a rational jury to conclude that certain statements were material to the Department of the Treasury, which was the predicate for counts charging fraud against the United States and making false statements thereto. The government did not submit evidence that the alleged misstatements were capable of influencing a decision of the Treasury Department (which was kept away from information of this type in making buy and sell decisions for mortgage-backed securities), and at most showed that the misrepresentations had a minor effect on the aggregate data submitted to Treasury that drove actual decisions. At the same time, the court concluded that it could not be said as a matter of law that the statements were immaterial to a reasonable investor for the purpose of the securities fraud counts of the indictment. The defendant argued that the statements affected the securities' prices but not their value, but several counterparties to the transactions testified that the misrepresentations were "important" to them.

On the same day Litvak was decided, the First Circuit vacated an SEC administrative order imposing suspensions and civil penalties on the Chief Investment Officer and a vice president of an investment advisor to a fund heavily invested in mortgage-backed securities. Flannery v. Securities & Exch. Comm'n, Nos. 15-1080 etc., ___ F.3d ___, 2015 WL 8121647 (1st Cir. Dec. 8, 2015). In the administrative proceedings, the SEC's Administrative Law Judge had dismissed the proceeding after an extensive hearing, only to be overruled by a 3-2 vote of the full Commission as to certain documents (a slide used by the vice president in an investor presentation, and two letters to clients attributed to the CIO). The appellate court held that the letters were not misleading as a matter of law. The SEC had misread the first letter and misinterpreted the economics of the transactions contemplated therein, rendering it unnecessary to decide whether an equivocal phrase in the second letter was misleading (as the SEC had levied liability under Securities Act Section 17(a)(3), which requires a practice or course of fraud rather than a single occurrence). The court also held that the materiality of the challenged slide, which portrayed sector asset allocations for the typical portfolio in the fund and labeled the fund as "high quality," was "marginal" at best, especially when considered in context-for one thing, it was only one slide in a larger presentation explaining to clients why the fund had underperformed, and accurate portfolio composition information had been disclosed to clients in fact sheets available to investors. This was significant because "[t]his thin materiality showing cannot support a finding of scienter here." The defendant testified that investors had never focused on the type of information in the slide, and that he carried further information in case investors actually wanted to discuss sector assert allocation.

In contrast, Harman Int'l Industries, cited above, decided that a statement in a 10-K that there had been "very strong" sales of certain products was not puffery. The court purported to apply a capable of objective verification standard, yet it then decided that a statement may be actionable even if it does not report a metric if the statement could have been misleading in context. The products at issue, although only a small component of the company's total product portfolio, were part of a division that accounted for 70% of the company's sales, and the CEO had said he thought sales could double in the final quarter of the year. In the court's opinion, the statement was sufficiently "specific about product and time period" to be actionable.

F.  Class Certification

Further proceedings in Halliburton

Class certification remains the norm in securities cases, but with a few twists. In one sense, courts are (re-)adjusting to the Supreme Court's Hallibuton II decision, which maintained the fraud on the market presumption of reliance and required that defendants, in order to defeat class certification, rebut the existence of an efficient market at the certification stage by showing the lack of a price impact of alleged misrepresentations. Erica P. John Fund, Inc. v. Halliburton Co., 573 U.S. ___ (June 23, 2014). Thus, in Halliburton, on remand from the Supreme Court, the district court granted class certification only as to one of the six corrective disclosures alleged by the plaintiffs, where defendants submitted evidence sufficient to carry their burden as to the lack of a price impact as to the five other disclosures. Erica P. John Fund, Inc. v. Halliburton Co., 309 F.R.D. 251 (N.D. Tex. 2015). For two of the corrective disclosures at issue, there was no price impact because plaintiffs had not shown that the company had disclosed any new information related to its asbestos liability (the key issue in the case) that had not already been reflected by the market price because it had been disclosed earlier. More generally, the court found the defendants' experts' event studies and arguments more persuasive than those presented by plaintiffs' expert.

Ludlow v. BP, P.L.C.

Probably more important to class certification that Halliburton are the Supreme Court decisions in non-securities cases (such as Comcast Corp. v. Behrend) holding that Rule 23(e) requires plaintiffs to provide a coherent measurement of damages capable of resolution across the entire class.

This is illustrated in the most interesting class certification ruling of 2015, Ludlow v. BP, P.L.C., 800 F.3d 674 (5th Cir. 2015). In this Rule 26(f) interlocutory order, the Fifth Circuit affirmed a thoughtful class certification ruling of the district court in a lawsuit filed after an offshore oil rig disaster. The court affirmed the certification of a class and class period at the tail end of the period submitted by the plaintiffs, which challenged statements after the accident. Plaintiffs' expert's event study-based model calculated the out of pocket losses for this time period, with a "sound" methodology that allowed for adjustment if some of the corrective disclosures fell out of the case. While the district court had expressed misgivings with the details of the model-most notably, whether certain alleged corrective disclosures actually corrected challenged prior statements-and defendants' argument "does not lack purchase," the district court was not required to resolve those concerns at the certification stage; any errors in identifying the corrective disclosures would apply to the entire class, and hence was a common issue that need not be proved at the certification stage per Amgen. As to the rest of the class period, however (which addressed statements about safety and compliance prior to the disaster), the district court did not abuse its discretion in denying certification based on the lack of a common damages theory at the class certification stage, where plaintiffs argued a "materialization of the risk" theory to urge that when the disaster occurred, the entire drop in stock price was recoverable across the class. Plaintiffs' theory hinged on an individualized question of whether one would have purchased stock at all were it not for the alleged misrepresentations. This is an individualized inquiry because different investors would have different oil spill risk investment criteria; some may have purchased even if the risk was far greater than what the company represented, albeit at a risk-adjusted price. The fraud on the market theory does not provide any presumptions regarding loss causation, as distinguished from reliance; and plaintiffs' own model may have rebutted the presumption in any event.

District Court decisions

A District Court judge reached a different result from the implication of Comcast in Fosbre v. Las Vegas Sands Corp., No. 2:10-cv-00765-APG-CWH, 2-15 BL 188219 (D. Nev. June 15, 2015). The court granted a motion to extend a class period by opining that under Ninth Circuit law, Comcast does not create a hard and fast rule that requires damages to be calculable on a class-wide basis as a prerequisite to certification.

Also at the district court level, Gordon v. Sonar Capital Mgmt. LLC, No. 11-cv-9665 (JSR), 2015 BL 75107 (S.D.N.Y. Mar. 19, 2015), denied without a prejudice a motion for class certification of a lawsuit alleging insider trading by hedge fund defendants in the securities of the company purchased by plaintiffs. The proposed representative for one of the classes sought to be certified had consulted his cousin, his long time attorney, who had reached an agreement with co-lead counsel firm to recover 5% of any recovery awarded to that firm-but the class representative and the firm had not disclosed this arrangement at the lead counsel hearing, even when the judge specifically had asked where there was a fee-sharing arrangement with "referring counsel." The proposed class representative for the other class had not suffered any net economic loss on his transactions.

Finally, two district court judges reached different conclusions on the effect of a plaintiff's post-class period stock purchases. Petrie v. Electronic Game Card, Inc., 308 F.R.D. 336 (C.D. Cal. 2015), held that such purchases did not automatically disqualify a plaintiff as a class representative, based on a survey of case decisions and the lack of a definitive ruling on the issue from the controlling Ninth Circuit. In contrast, Steginsky v. Xcelera, Inc., No. 3:12-cv-188 (SRU), 2015 BL 63295 (D. Conn. Mar. 10, 2015), denied class certification in part in a lawsuit alleging that the controlling shareholders of a technology conglomerate company schemed to deflate the stock price in order to acquire it at a lowball price, where the class representative had taken extraordinary steps to investigate the transaction before proceeding: she thought the price was too low, requested but did not receive more information, believed the defendants were perpetrating a fraud, talked to counsel, and planned to sue, but sold her shares anyway because she needed the money.

G.  Loss Causation

Again, the year's developments in this element started in December 2014, when the Ninth Circuit held that this element must be pleaded with Rule 9(b) particularity in Oregon Public Employees Retirement Fund v. Apollo Group, Inc., cited above. Other than this, 2015 decisions reflected each Circuit's application of its loss causation theories, where some Circuits have not adopted a so-called "materialization of the risk" theory and instead require corrective disclosures. For example, Nakkhumpun v. Taylor, cited above, found that loss causation was alleged on a materialization of the concealed risk theory, which requires (1) the risk that materialized was within the zone of risk concealed by the misrepresentation (foreseeability) and (2) the materialization of the risk caused a negative impact on the value of the securities (causal link). According to the court, the risk concealed by a false statement regarding the potential value of the company's key asset materialized when the company announced (sixteen months later!) that it was unable to find a buyer for the asset.

A loss causation issue that divides the courts is whether the announcement of a government investigation, by itself, creates loss causation when the stock price reacts negatively to this news. The answer in the Ninth Circuit is no, and hence loss causation was not alleged based on disclosure of a government investigation in Paddock v. Dreamworks Animation SKG, No. CV 14-06053 SJO (Ex), slip op. (C.D. Cal. Apr. 1, 2015). In contrast, Thorpe v. Walter Investment Management Corp., No. 1:14-cv-20880-UU, 2015 BL 208626 (S.D. Fla. June 30, 2015), held that loss causation was alleged in part based on the disclosure of government investigations into a loan servicing company. In our assessment, the Ninth Circuit position is sounder: an investigation is not the same as liability, and the federal securities laws do not insure investors against a risk that an issuer will be investigated, accused or sued. As another 2015 decision well said, "bad news" is not the same as loss causation. In re Francesca's Holdings Corp. Sec. Litig., No. 13-cv-6882 (RJS), 2015 BL 109146 (S.D.N.Y. Mar. 31, 2015).


In 2015, courts continued to address the implications of the Supreme Court's decision in Chadbourne & Parke LLP v. Troice, __ U.S. ___, 134 S. Ct. 1058 (2014), which held that claims against alleged aiders and abettors of the J. Allen Sanford Ponzi scheme were not covered by the Securities Litigation Uniform Standards Act of 1998 ("SLUSA"), because the misconduct at issue was not in connection with the purchase or sale of a "covered security." In that case, investors purchased certificates of deposits issued by a foreign bank controlled by Sanford, which were "debt assets that promised a fixed rate of return." The CDs did not own covered securities, and plaintiffs were not told that they would own covered securities (that is, securities traded on a national exchange) if they purchased the CDs. Rather, the bank allegedly misrepresented that it would use the proceeds of the sales of the CDs to buy assets (including covered securities) that it, not the plaintiffs, would own. The Court thus held that SLUSA did not apply because the misrepresentations were not material to any decision by plaintiffs (as distinguished from the fraudsters) to purchase or own covered securities.

Chadbourne & Parke did not address a situation found in some major scams (such as the Bernard Madoff fraud): investors are told that their funds will be invested in covered securities, but the vehicle through which the investments are made is a fund (such as a feeder fund) that the investors will own but which is not itself publicly traded. In 2014, the Second Circuit reasoned that Chadbourne & Parke was inapposite and that SLUSA applied in that situation. In re Herald, Primeo & Thema, 753 F.3d 110 (2d Cir. 2014) (per curiam).

In 2015, the Second Circuit again addressed this context in In re Kingate Management Ltd. Litig., 784 F.3d 128 (2d Cir. 2015), which vacated the dismissal of a lawsuit filed by investors in other Madoff feeder funds. The court clarified that the question of whether SLUSA applied to a particular defendant depends on the allegations particular to that defendant. The court also held that claims not based on alleged misrepresentations or aiding and abetting another person's fraud, but rather based on duties of care that existed independent of the type of security in which plaintiffs invested (such as duties owed by accountants or financial advisors), are not encompassed by SLUSA. The court, however, reaffirmed that Chadbourne & Parke was inapposite, as in the instant case investors had intended to invest in covered securities and were told that their monies would be invested in that manner. See also Marchak v. JPMorgan Chase & Co., 284 F. Supp. 3d 197 (E.D.N.Y. 2015) (same); Knopick v. UBS Financial Services, Inc., No. 14-05639, 2015 WL 4931480 (E.D. Pa. Aug. 18, 2015) (SLUSA applied where complaint carefully tried to avoid alleging the type of securities plaintiff had purchased, but account statements showed he had purchased covered securities).

Kingate's effect is evident in Anwar v. Fairfield Greenwich Ltd., No. 09 Civ. 118 (VM), ___ F. Supp. 3d ___, 2015 WL 4610406 (S.D.N.Y. July 29, 2015), which addressed claims against auditors and financial advisors to other Madoff feeder funds. In 2010, the court had held that the connection between the plaintiffs' investment in the feeder funds was too attenuated with Madoff's investments in "covered securities" to apply SLUSA. In 2015, in light of Chadbourne & Parke and Kingate, the court reversed course; among other things, it noted that "Kingate, however, has all but foreclosed such a distinction" between the financial advisor defendants (whose connection to Madoff was close) and the auditor defendants (whose connection was more remote). As in Kingate, claims based on breaches of duties of care that existed independent of the type of security in which plaintiffs invested were not encompassed by SLUSA. These claims were professional negligence against the feeder funds' auditors, based on the breach of a duty of care to conduct proper audits that existed even though there was not a contractual relationship to the investors; and "Due Diligence Claims" (breach of fiduciary duty, negligence, and gross negligence) based on allegations that the defendants failed to properly investigate the feeder funds before making representations to their clients.

Another prominent SLUSA issue in 2015 was whether the statute removed State court jurisdiction over class actions asserting claims under the Securities Act. Pacific Mgmt. Co v. American Int'l Group, Inc., No. SA CV 15-0687-DOC (DFMx) (C.D. Cal. June 10, 2015); and Plymouth County Retirement Sys. v. Model N, Inc., No. 14-cv-04516-WHO (N.D. Cal. Jan. 5, 2015), typify the decisions holding that State court jurisdiction still exists. As the appellate courts have not addressed the issue, it remains open.

I.  SEC's Use Of Administrative Proceedings

Last but not least, another major federal securities topic for the year was the intense debate over the constitutionality of SEC administrative proceedings to address alleged insider trading and other securities laws violations.

Jarkesy v. Securities & Exch. Comm'n, ___ F.3d ___, No. 14-5196 (D.C. Cir. Sept. 29, 2015), affirmed the dismissal for lack of subject matter jurisdiction of a district court action challenging the SEC's use of in-house administrative enforcement proceeding against a hedge fund manager. (See also Tilton v. Securities & Exch. Comm'n, No. 15-CV-2472 (RA), slip op. (S.D.N.Y. June 30, 2015) (reaching same conclusion)). The plaintiff sought to enjoin the administrative proceedings on the basis of Fifth Amendment Due Process, Equal Protection (based on the Seventh Amendment and other grounds), improper ex parte communications, and Brady violations. According to the court, it was dispositive that under the statutory scheme, the plaintiff could secure judicial review in a Court of Appeals when and if the administrative proceeding culminated in an adverse resolution. By enacting this comprehensive, painstakingly detailed system, Congress intended that a litigant proceed exclusively through it. There was no strong countervailing rationale in the type of challenges presented by the plaintiff to unsettle the presumption of initial administrative review. Here, the court noted that plaintiff's complaint had not actually made some of the challenges on which his argument relied; for example, the complaint had not challenged Congress' decision in Dodd-Frank to expand the scope of administrative proceedings as a violation of the Seventh Amendment. In the end, an Article III court (a Court of Appeals) eventually could rule on all of plaintiff's constitutional claims-this happens all the time-so it is of no dispositive significance that those claims would first be considered in the administrative tribunal. The court also opined that plaintiff had underestimated the SEC's ability to address the constitutional and other issues presented by his challenge.

In contrast, Gray Financial Group, Inc. v. Securities & Exch. Comm'n, No. 1:15-CV-0492-LMM (N.D. Ga. Aug. 4, 2015), preliminary enjoined administrative proceedings in a lawsuit challenging the constitutionality of SEC in-house tribunal. (The same judge had issued a similar ruling in Hill v. Securities & Exch. Comm'n, No. 1:15-CV-1801-LMM (N.D. Ga. June 8, 2015), and her opinion addressed the SEC's criticism of that prior opinion.) The court determined that it had subject matter jurisdiction under 28 U.S.C. §1331 (and §2201, which authorizes declaratory judgments), rejecting the SEC's argument that the exclusive path to complain about the proceedings was through the Courts of Appeals because Congress allows the SEC to choose its internal forum over suing in District Court; in reality, the court reasoned, the District Court option shows that Congress did not intend the administrative-to-Court of Appeals path to be the exclusive one. Moreover, the court could and did presume that Congress did not intend to limit federal court jurisdiction under the standards governing that inquiry. First, barring plaintiffs' claims could foreclose all meaningful judicial review, as it would force plaintiffs to undergo the very process they contend is unconstitutional and result in a moot claim at the end (as the Court of Appeals could not enjoin an administrative proceeding that already had concluded). Second, plaintiffs' lawsuit was wholly collateral to the statute's review provisions. Third, plaintiffs' claims (which go to the constitutionality of the statutory scheme, not the merits of the case or even the SEC's conduct of its internal proceedings) are outside the agency's expertise. On the merits, the court agreed that the administrative system violated the Appointments Clause of Article II. As ALJs are "inferior officers" for purposes of this clause (and not "mere employees"), they must be appointed by the President, court or department head. The public interest supported an injunction because citizens should not be subject to unconstitutional treatment by the government, and the SEC would not be prejudiced by a delay (not that this would trump the former point in any event). See also Duka v. Securities & Exch. Comm'n, 15 Civ. 357 (RMB) (SN), slip op. (S.D.N.Y. Aug. 3, 2015) (reaching same conclusion).