Federal Securities Litigation and Regulation: A Periodic Review and Predictions for the Remainder of 2019

While the past year, or even eighteen months, was short on landmark federal securities law decisions, there was significant activity on the part of private securities litigants. In 2018, plaintiffs filed 403 new federal securities fraud class actions, just short of 2017’s record high of 412.¹ This continued a marked uptick in securities filings over the last two years. After 20 years with an average of only 203 new filings per year, the pace has now nearly doubled.² This increase was driven in part by the emergence of securities cases relating to mergers and acquisitions. As few as 13 such cases were filed per year in the early 2010s, but 198 were filed in 2017 and 182 in 2018.³ So far in 2019, there have been 134 securities class actions filed, signaling that the trend is continuing. This increase may have resulted at least in part from decisions by the Delaware Court of Chancery severely restricting the ability of stockholders to resolve breach of fiduciary duty claims against directors in the M&A context with non-monetary settlements whereby the company makes supplemental disclosure, pays the plaintiff’s attorney a fee, and defendants receive class-wide releases.⁴ Given that this avenue for quick resolution of M&A litigation is now effectively foreclosed in the absence of clearly material supplemental disclosure, it appears that certain stockholders have migrated to federal court asserting federal securities law claims instead.

At the same time, the lower federal courts have been prolific in issuing opinions on a range of important issues affecting private securities litigants. In the process, courts attempted to mediate between their perception that private lawsuits are necessary to protect investors and promote ethical business practices while also recognizing the significant potential for abuse in this area, including the filing of meritless lawyer-driven suits.

• The Supreme Court issued two significant decisions in 2018, clarifying that the statute of limitations for a successive class action is not tolled by a prior class action (China Agritech, Inc. v. Resh) and that plaintiffs may bring class actions asserting claims under the Securities Act of 1933 (Securities Act) in state courts (Cyan, Inc. v. Beaver County Employees Retirement Fund). In addition, the Supreme Court opened 2019 by holding that an individual who is not the “maker” of a fraudulent statement may nonetheless be held primarily liable under the federal securities laws for disseminating the fraudulent misstatement (Lorenzo v. Securities and Exchange Commission)—a decision that, according to Justice Thomas in dissent, renders the Court’s landmark 2011 decision in Janus Capital Group, Inc. “dead letter.”
• The federal courts of appeal decided what state law class actions may be brought in federal courts (Brink v. Raymond James & Assocs., Inc. (11th Cir.)); a defendant’s burden in rebutting a presumption of market efficiency on class certification (Arkansas Teachers Ret. Sys. v. Goldman Sachs Grp., Inc. (2d Cir.)); the state of mind necessary for liability under Section 14(e) of the Securities Exchange Act of 1934 (Exchange Act) (Varjabedian v. Emulex Corp. (9th Cir.)); and whether a securities action must be dismissed when a plaintiff loses standing, or the court retains jurisdiction to substitute a new plaintiff to cure the defect (Klein v. Qlik Techs., Inc. (2d Cir.)).
• The federal district courts have been particularly active, issuing decisions on a wide range of issues, including: what triggers the tolling of the limitations period under the Exchange Act; federal preemption of state law securities fraud class actions; the parties’ burden in establishing—or defeating—a presumption of class-wide reliance on class certification; selection of lead plaintiff and class representative in securities class actions; what types of traders may be included in the definition of a plaintiff class in a securities class action; what allegations are sufficient—and not—in order to meet pleading standards under the Private Securities Litigation Reform Act (PLSRA); and whether a putative class action must be dismissed when the named plaintiff loses standing.

The federal courts also issued significant decisions impacting entities and individuals facing regulatory issues or potential government investigations. The Supreme Court narrowed the definition of who qualifies as a whistleblower in a decision (Somers v. Digital Realty Trust) that may impact employees’ willingness to report potential misconduct internally before “reporting out” to the Securities and Exchange Commission (SEC) or other regulator. The Second Circuit also revisited a significant decision addressing the personal benefit requirement in insider trading cases (U.S. v. Martoma). The Second Circuit also revisited a significant decision addressing the personal benefit requirement in insider trading cases (U.S. v. Martoma). The Second Circuit amended its earlier decision in Martoma and left Newman’s “meaningfully close” personal relationship test intact but concluded that the test can be met where the tipper gives the information to the tippee with the intent to benefit. On petition to the Supreme Court, Martoma challenges the Second Circuit’s holding that a mere intent to benefit without a meaningfully close personal relationship is sufficient to establish liability.

Meanwhile, the SEC continued its regulatory focus on retail investors and cyber issues. Enforcement activity by the SEC unexpectedly increased in FY 2018, particularly in the second half of the year. Overall, the SEC filed 821 total actions in FY 2018, a significant increase from FY 2017.⁵ Consistent with the agency’s focus on retail investors, this included substantial increases in the number of securities offering cases, cases against investment advisers and investment companies, and cases against broker dealers. During the second half of FY 2018, the SEC filed a record-setting 55 new actions against public companies and subsidiaries,⁶ compared with only 15 in the first half of 2018.⁷ At the same time, the number of issuer reporting and disclosure actions—often the largest and most complex cases the SEC brings—decreased significantly in FY 2018.

We discuss these developments, and look ahead to the remainder of 2019, below.

In recent years, the Supreme Court has focused on clarifying the circumstances under which the statute of limitations applicable to federal securities law claims is tolled in light of prior-filed suits. In the seminal case of American Pipe & Construction Co. v. Utah, ⁸ the Supreme Court held that the commencement of a class action extends (or tolls) the statute of limitations applicable to claims by individual class members, allowing them to intervene in the action if class certification is ultimately denied. In Crown, Cork & Seal Co., Inc. v. Parker,the Court extended American Pipe to allow tolling for individual suits by class members, regardless of whether they intervene in the prior action or commence new individual suits following denial of class certification. In 2017, however, the Supreme Court put limits on what seemed to be a situation where tolling could go on nearly endlessly. In California Public Employees’ Retirement System v. ANZ Securities, Inc.,⁹ the Court held that American Pipe tolling only applies to the one-year statute of limitations under the Securities Act; it does not apply to the three-year statute of repose, which was intended to be an absolute bar to suits brought more than three years after the challenged fraud.

In 2018, the Supreme Court again revisited the concept of American Pipe tolling, and again came down in favor of imposing absolute time limits. In China Agritech, Inc. v. Resh,¹⁰ the Supreme Court considered whether American Pipe tolling not only extends the statute of limitations for individual suits but also for new putative class actions. In China Agritech, an investor sought to bring a class action outside the two-year statute of limitations under the Exchange Act. The investor argued that the statute of limitations was tolled under American Pipe by a prior class action of which he was a class member. The Ninth Circuit accepted the investor’s argument, holding that the same equitable considerations that warrant tolling of successive individual suits under American Pipe also apply to successive class action suits. But the Supreme Court reversed, holding that the American Pipe doctrine does not apply to successive class actions. Writing for eight justices, Justice Ginsburg explained that the American Pipe doctrine tolls individual claims because “economy of litigation favors delaying those claims until after a class-certification denial.”¹¹ It would be wasteful to encourage the filing of individual suits when class certification may obviate the need for such suits.¹² In contrast, economy of litigation does not favor encouraging successive class suits. Rather, it would be more efficient for all would-be class representatives to come forward at the outset of a case for a binding, global decision on class representative status.¹³ Moreover, unlike individual claims (for which the clock would start running again after class certification denial), there could be no end date for class claims because the statute of limitations would be tolled during the pendency of each successive class action.¹⁴ Justice Ginsburg also explained that the Court’s holding was consistent with the policy goals of Rule 23 of the Federal Rules of Civil Procedure and the Private Securities Litigation Reform Act, which each express a preference for early resolution of class certification issues, including the early selection of lead plaintiff and class representative.¹⁵

Although the case under review in China Agritech only involved claims under the Exchange Act, Justice Ginsburg’s opinion could be construed to apply not only to...