This quarter’s issue includes summaries and associated court opinions of selected cases principally decided between July and October 2020.
- Class Certification
- Cryptocurrency – Definition of a Security
- Derivative Litigation – Demand Futility
- Fiduciary Duties
- Insider Trading Claims
- Investment Company Act
- Loss Causation
- PSPSLRA Safe Harbor Provision
- SEC Enforcement Actions
-
Securities Fraud Pleading Standards
- Misrepresentations
- Omissions
- Scienter
- Standing
Seventh Circuit Vacates and Remands Class Certification in Securities Fraud Action
Carpenters Pension Tr. Fund for N. Cal. v. Allstate Co., No. 19-1830 (7th Cir. July 16, 2020)
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In a securities fraud case against Allstate Corporation, the Seventh Circuit vacated certification of a plaintiff class for legal error and remanded the case for further consideration.
In early 2013, Allstate announced it would be “softening” underwriting standards for its auto insurance business in an effort to attract new customers and increase profitability, but it acknowledged the softer standards held the risk of increasing auto claims frequency. The company’s CEO said the company would monitor claims frequency and adjust business practices as necessary. Two years later, Allstate announced that the growth strategy had indeed increased claims frequency and that it would be retightening underwriting standards. Its stock immediately dropped by more than 10 percent.
The plaintiffs, purchasers of Allstate securities after its 2013 announcement, brought a securities fraud class action against Allstate under SEC Rule 10b-5, alleging that claims frequency had increased almost immediately once the softened underwriting standards were implemented but that Allstate withheld this information until its announcement two years later.
As required by Rule 23(b)(3), the plaintiffs introduced evidence at the certification stage that questions of law or fact common to all the class members predominated over any questions unique to individual members. To show they could use common evidence to prove reliance, an element of a securities fraud claim, the plaintiffs invoked the Basic fraud-on-the-market presumption of reliance. Under Basic, Inc. v. Levinson, 485 U.S. 224 (1988), if plaintiffs prove that the securities at issue were traded in an efficient market, such that the security price reflected all public information (including the alleged misrepresentations), reliance is presumed.
Allstate offered rebuttal evidence that the alleged misrepresentations did not actually affect the price of the securities at issue, which the district court declined to examine. The district court concluded that the issue of price impact was too intertwined with the merits and so could not be decided at the class certification stage.
The Seventh Circuit remanded with instructions that the district court was to engage with Allstate’s evidence on price impact for the purpose of assessing whether the plaintiffs properly invoked the Basic presumption. The district court was not permitted to draw even obvious inferences about topics forbidden at the certification stage, materiality and loss causation, despite the conceptual overlap.
The Seventh Circuit acknowledged that the same evidence may ultimately be relevant to proving all three issues but concluded that this bifurcated analysis was required by U.S. Supreme Court precedent in Erica P. John Fund, Inc. v. Halliburton Co., 563 U.S. 804 (2011), Amgen Inc. v. Connecticut Retirement Plans & Trust Funds, 568 U.S. 455 (2013), and Halliburton Co. v. Erica P. John Fund, Inc., 573 U.S. 258 (2014).
Cryptocurrency – Definition of a SecuritySDNY Holds That Cryptocurrency Is a Security
SEC v. Kik Interactive, Inc., No. 19 Civ. 5244 (AKH) (S.D.N.Y. Sept. 30, 2020)
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Judge Alvin K. Hellerstein granted summary judgment to the Securities and Exchange Commission (SEC) on its claims against a cryptocurrency coin issuer, alleging it violated Sections 5(a) and 5(c) of the Securities Act by offering and selling securities without a registration statement or an exemption from registration. The coin issuer argued that its coins were not securities, and even if they were, the coins sold during a private presale, before its public offering, and thus were exempt from registration requirements under Regulation D.
The court held that the company’s coins were securities under the U.S. Supreme Court’s decision in SEC v. W.J. Howey Co., 328 U.S. 293 (1946). Under Howey, an investment contract is a security where there is “(i) an investment of money (ii) in a common enterprise (iii) with profits to be derived solely from the efforts of others.” The court determined that the SEC adequately alleged a “horizontal commonality” in which the funds raised through purchases of the company’s coins were pooled together to develop the company’s blockchain technology, and the success of that technology would raise the value of the purchasers’ coins. The court also clarified that in the Second Circuit, the expectation of profits need not literally be “solely” from the efforts of others, but rather that “the scheme was being promoted as primarily as an investment or as a means whereby participants could pool their own activities, their money and the promotor’s contribution in a meaningful way.” The court determined that the coin issuer promoted the coin as an investment.
The court rejected the coin issuer’s argument that transactions from a private presale were exempt under Regulation D, finding that the presale was integrated with the public offering. Under Regulation D, the court must consider these factors to determine if the transactions are actually one integrated transaction: “(a) Whether the sales are part of a single plan of financing; (b) Whether the sales involve issuance of the same class of securities; (c) Whether the sales have been made at or about the same time; (d) Whether the same type of consideration is being received; and (e) Whether the sales are made for the same general purpose.” Giving more weight to the first and fifth factors, consistent with precedent, the court held that the presale and public offering “were part of a single plan of financing and made for the same general purpose,” as evidenced by, for example, the fact that the success of the presale relied on the public offering, that the purchasers all “received the same class of securities” and that the two sales “took place at about the same time.”
Derivative Litigation – Demand FutilityEastern District of Missouri Dismisses Derivative Action Alleging Securities Violations
Carpenters Pension Fund of Ill. ex rel. Centene Corp. v. Neidorff, No. 4:18 CV 113 CDP (E.D. Mo. Sept. 15, 2020)
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Judge Catherine D. Perry granted the directors and officers of Centene Corporation’s motion to dismiss a derivative action filed by several of its shareholders. The derivative action alleged that the board of directors issued or approved false and misleading statements related to Centene’s acquisition of Health Net. Specifically, the proxy statement and prospectus issued to shareholders prior to their approval of the merger failed to disclose Health Net’s financial problems and liabilities. Once these issues were disclosed, the plaintiffs alleged, Centene’s stock price dropped more than 8%.
The defendants moved to dismiss, arguing that the shareholders failed to state a claim upon which relief could be granted and failed to demonstrate demand futility. Among other allegations, the shareholders contended that the directors violated the Securities Act and the Securities Exchange Act by issuing false and misleading SEC statements that concealed Health Net’s financial issues.
The shareholders argued that demand was excused for their securities claims because making false and misleading statements in violation of securities laws is not protected by the business judgment rule. While the court agreed that such conduct would excuse demand, it held that the complaint failed to plead particularized facts supporting the allegation that the board acted with conscious awareness of illegality.
The complaint generally alleged the board faced liability for making false statements but only identified specific knowledge or conduct by one director and two audit committee members. The court found the board’s general approval of the SEC filings insufficient to infer knowledge of falsity, absent specific allegations of directors’ personal involvement in the preparation of the filings. Further, the complaint failed to plead that outside directors had sufficient knowledge of the day-to-day workings of Centene to impute knowledge of allegedly false statements made by the president and CEO. Finding no likelihood that the majority of the board faced personal liability for securities law violations, the court held that the complaint failed to plead particularized facts to cast reasonable doubt on the disinterest or independence of the majority of the board.
The court likewise found that the plaintiffs’ allegations related to breach of fiduciary duties, insider trading and unjust enrichment failed to demonstrate demand futility. Accordingly, the court granted the defendants’ motion to dismiss.
An appeal of this decision was filed with the Eighth Circuit on October 22, 2020.
Fiduciary DutiesDelaware Court of Chancery Denies Motion To Dismiss ‘Paradigmatic Revlon Claim’ Alleging Fraud on the Board
In re MINDBODY, Inc., Stockholders Litig., No. 2019-0442-KSJM (Del. Ch. Oct. 2, 2020)
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The Delaware Court of Chancery denied a motion to dismiss breach of fiduciary duty claims against both the chairman/CEO and the chief financial officer/chief operating officer of MINDBODY, Inc. (Mindbody) arising from the sale of Mindbody to Vista Equity Partners (Vista). The court granted the motion to dismiss as to an outside...
