Pomerantz Scores Major Victory in Investor Suit Against Y-mAbs

POMERANTZ MONITOR | MARCH APRIL 2024

By The Editors

In February 2024, Pomerantz overcame defendants’ motion to dismiss a major investor suit against Y-mAbs Therapeutics, Inc. and its executives. The case alleges that Y-mAbs made numerous misleading statements about the FDA approval process for its primary product, omburtamab.

Y-mAbs is a clinical biopharmaceutical company headquartered in New York that develops and markets antibody-based therapies. In 2020 and 2021, Y-mAbs’ leading drug candidate was omburtamab, a therapy designed to treat neuroblastoma, a type of cancer that forms in nerve cells. In 2020, Y-mAbs submitted a Biologics License Application (“BLA”) as part of the FDA approval process for omburtamab. In the application, Y-mAbs included a single-arm study comparing the overall survival results of patients using omburtamab with an external control constructed using data from the Central German Childhood Cancer Registry (“CGCCR”), rather than with a study control group. However, the company received a Refusal-to-File (“RTF”) letter from the FDA indicating substantial flaws in the data Y-mAbs presented in its application. Y-mAbs issued a press release on October 5, 2020 informing investors of the RTF letter, but without actually publishing the contents of the letter. Instead, they assured the market that the RTF was issued merely for non-substantive reasons. Y-mAbs confirmed that the letter contained “new issues being raised that hadn’t been discussed previously,” but portrayed the FDA’s concerns optimistically, saying that it was a “minor setback,” “not a problem,” they “have everything” to cure the deficiencies, and that there was “no concern that the FDA will think, ‘Oh, that is not sufficient response.’”

In reality, since 2016 the FDA had repeatedly warned the company that the patient population in the study Y-mAbs submitted was not comparable to the population in the CGCCR. Contrary to what the company claimed, these deficiencies were not “new issues.” Additionally, Y-mAbs and its executives knew they could not fully address all the points the FDA raised, as a satisfactory resubmission called for a comparison of patients who had also received craniospinal irradiation, which the CGCCR dataset did not contain.

The FDA maintained its position as it discussed the resubmission of the BLA with Y-mAbs in January 2022, reiterating that the CGCCR data was fundamentally flawed and that Y-mAbs did not provide sufficient information to support the BLA. The FDA told Y-mAbs that it had failed to adequately address the deficiencies that the agency had identified and that aspects of the Y-mAbs analysis were “arbitrary.” Ultimately, the FDA informed Y-mAbs that if the company could not provide an adequate comparator, “an alternative clinical development program” would need to be discussed. Despite this feedback, Y-mAbs went out of its way to reassure investors that “all the information that we need, we have,” and the FDA and Y-mAbs were “aligned” on the resubmission. The company even claimed that there was a “clear regulatory path forward,” and the resubmission was “progressing as planned.”

Y-mAbs had previously told investors the company would not file the BLA until they “reach a final agreement with the [FDA]” and “get a green light.” However, on March 31, 2022, in keeping with a statement from a February earnings call in which Y-mAbs said it expected to resubmit the BLA by the end of the first quarter of 2022, the company resubmitted the BLA for omburtamab “prior to reaching agreement with the FDA on the content of the application.”

On October 26, 2022, the FDA released a Briefing Document for the Oncologic Drug Advisory Committee.  The document laid out the FDA’s findings that the clinical trials on which Y-mAbs had based its application were inadequate and not well-controlled, and therefore did not provide sufficient evidence that omburtamab is safe and effective.

Two days later the Advisory Committee unanimously voted to deny FDA approval for omburtamab. The committee concluded that the “difference in survival cannot be reliably attributed to omburtamab.” On this news, Y-mAbs’ share price plummeted over 76%.

The court reviewed defendants’ motion to dismiss by dividing the alleged false statements into four categories: statements regarding timing of resubmission, statements regarding progress towards resubmission, statements interpreting clinical data, and statements interpreting FDA feedback and guidance.

The first category covers statements regarding the future timing of resubmission, such as “[we] expect this year to complete our BLA submission.” The court held that such statements were not actionable as they constituted forward-looking statements or opinions, which are protected by the PSLRA’s safe harbor for forward-looking statements.

The second category comprises statements regarding progress towards resubmissions. Examples of these statements include that the resubmission was “going as planned” and “progressing well.” The court decided that these statements were not actionable under Omnicare, which established that a “reasonable investor” may understand an opinion statement to convey facts about how the speaker formed the opinion. As the FDA continued to meet with the company, the court concluded that this point fell short of a “serious conflict” between the FDA’s interim concerns and the defendants’ optimism. Even though the statements “fail[ed] to disclose the FDA’s repeated statements of concern,” the court reasoned that the FDA’s interim feedback did not actionably conflict with defendants’ statements about FDA approval because the optimistic statements were consistent with the FDA’s guidance about how deficiencies could be overcome.

The third category consists of statements interpreting clinical data. When defendants interpreted Study 03-133 and Study 101, they stated that there is a clear “clinical benefit in terms of response rates and survival.” The court rejected the assertion that these statements were misleading because they do not claim that the FDA had interpreted the studies similarly.

The most consequential category of statements was the fourth: statements interpreting FDA feedback and guidance. For example, in May 2022, defendants stated that a “pre-BLA meeting with the FDA in January” had “confirmed our path towards our March BLA resubmission, which we ultimately achieved.” The court upheld plaintiffs’ allegation that statements by Y-mAbs characterizing FDA feedback and guidance were materially misleading. The court distinguished statements interpreting FDA feedback from the optimistic statements it found nonactionable because they described “the current state of resubmission” rather than future optimism. The court ruled that, even if these statements were opinions, the company misled investors because the FDA had outstanding concerns that were never resolved when the company resubmitted the BLA. This finding opens a direct pathway for defrauded investors to pursue recovery for the significant damages they incurred by Y-mAbs’ misleading statements.

The court held that Pomerantz adequately alleged scienter, given y-mAbs’ knowledge of the FDA’s concerns, as demonstrated through the continuous communication between defendants and the FDA. The court also held that Pomerantz adequately alleged loss causation, writing, “each statement appears to contradict a warning by the FDA and these warnings were made clear in . . . the FDA Briefing Document, which was released just before the stock price fell.”

“Companies are allowed to be as optimistic as they want,” according to Pomerantz Partner Michael Wernke, who leads Pomerantz’s litigation of the case. “But they can’t be optimistic about what the FDA actually says.” While investors are overwhelmingly incentivized to applaud companies’ optimism about their products and progress, when corporate optimism mischaracterizes feedback from regulators and the news comes to light, investors must work to protect their rights in the face of corporate fraud. The case is now proceeding to discovery.

The FDIC’s Proposed Standards for Corporate Governance and Risk Management

POMERANTZ MONITOR | NOVEMBER DECEMBER 2023

By Michael J. Wernke

On October 11, 2023, the Federal Deposit Insurance Corporation published for comment in the Federal Register proposed standards for corporate governance and risk management (“Proposed Standards”) for the financial institutions it regulates that have $10 billion or more in total assets (“covered institutions”). Under its safety and soundness powers in Section 39 of the Federal Deposit Insurance Act, the FDIC is able to publish such standards that go beyond mere guidance. The new standards are part of the FDIC’s regulatory response to the bank failures that took place in the spring of 2023. Referring to the post-mortem evaluations conducted by the FDIC and the Federal Reserve Board following the Signature Bank and Silicon Valley Bank failures, the preamble to the Proposed Standards asserts that poor governance and risk management practices were contributing factors that led to the collapse of those banks.

The FDIC’s Proposed Standards are based on the principles set forth in the Office of the Comptroller of the Currency’s Guidelines Establishing Heightened Standards for Certain Large Insured National Banks, Insured Federal Savings Associations, and Insured Federal Branches (the “Heightened Standards”), but with key differences. The Proposed Standards include more details on what the FDIC expects from the boards of directors as well as the banks that the FDIC regulates. They also set a notably lower minimum asset threshold (five times lower) than the OCC’s Heightened Standards to determine which banks are covered.

The Proposed Standards were approved 3-2: Chairman Gruenberg, CFPB Director Chopra, and acting Comptroller Hsu voted in support; Vice Chairman Hill and Director McKernan voted against the proposal.

Comments on the Proposed Standards are due by February 9, 2024. (This date was extended from the original deadline of December 11, 2023).

Background

The FDIC’s Proposed Standards delve into legal issues that—in the case of banks that do not have a federal charter—have typically been determined by state law. These include the duties and responsibilities of bank boards, directors, and management, including their duties of care and loyalty, as well as related concepts such as the business judgment rule.

While banks are primarily governed by state corporate governance law, there are instances in which federal oversight is enforced. For example, federal law imposes audit standards and a gross negligence “floor” on the conduct of bank directors and officers. Federal law also requires that federal banking regulators impose operational and managerial standards, compensation standards, and appropriate standards relating to asset quality, earnings, and stock valuation.

Specifically, following the poor risk management that led to the 2008 financial crisis, federal banking regulators enacted increased oversight of the governance and risk management of banks. The OCC initially imposed heightened expectations for the governance and oversight of the larger banks that it regulated and, in 2014, it adopted those Heightened Standards as a specialized standard for safety and soundness at larger federally chartered banks. Also in 2014, the Federal Reserve implemented part of the Dodd-Frank Act by establishing several risk management requirements for larger bank holding companies. This was followed in 2021 by expectations for effective governance by larger bank boards. 

Proposed Guidelines

Note that in some specific instances, a covered institution may leverage its parent company’s risk management program or board to meet the standards of the Proposed Guidelines.

Obligations Covered directors would have a duty to safeguard the interests of the bank, confirming that the bank operates in a safe and sound manner and in compliance with applicable federal and state law. In supervising the bank, a board should consider the interests of all of its so-called stakeholders, going beyond shareholders and depositors to include creditors, customers and even the regulators themselves.

Composition The Proposed Guidelines set out minimum standards for board composition, requiring a majority of its members to be independent and outside directors. Boards would also be expected to consider the diversity of their members, including social, seniority, and educational differences, among others. The Proposed Guidelines also caution against excessive influence from a “dominant policymaker.”

Duties Covered boards would need to (i) set an appropriate tone and establish a responsible, ethical corporate culture; (ii) evaluate and approve a strategic plan; (iii) approve and annually review policies; (iv) establish and annually review a written code of ethics; (v) actively oversee the bank’s activities, including all material risk-taking activities; (vi) exercise independent judgment; (vii) select and appoint qualified executive officers; (viii) establish and adhere to a formal training program; (ix) conduct an annual self-assessment of its effectiveness; and (x) establish and annually review compensation and performance management programs.

Committees The Proposed Guidelines require boards to maintain a risk committee and compensation committee in addition to the audit committee required by Section 36 of the FDI Act and Part 363 of the FDIC’s regulations. Risk committees would need to meet at least quarterly and maintain records of their proceedings, including risk management decisions.

Risk Management The Proposed Standards would impose expectations for the risk management program that a bank should develop and maintain. These expectations largely match the OCC’s Heightened Standards. For example, like the Heightened Standards, the Proposed Guidelines would require covered institutions to adopt a three-lines-of-defense risk management framework with a front-line unit (exclusive of the legal department), an independent risk management unit led by a Chief Risk Officer, and an internal audit unit led by a Chief Audit Officer.

The Proposed Guidelines provide that the risk management program would need to address a wide variety of potential risk categories, ranging from credit, interest rate, and liquidity risks to anti-money laundering and third-party partnership and outsourcing risks. Further, material breaches of risk limits and emerging risks would need to be reported in a timely manner to the board and the chief executive officer.

Identifying and Reporting Violations of Law The Proposed Guidelines would require a covered institution’s board to establish and annually review processes that would require either front-line units or the independent risk unit to report all violations of applicable laws and regulations to law enforcement or any appropriate federal or state regulatory agency. This would represent a shift from the FDIC’s current practice of encouraging, but not requiring, self-reporting of violations.

Questions The FDIC asks multiple questions in order to scope banks that should be subject to the Proposed Guidelines, including whether FDIC-supervised institutions with $10 billion or more in total consolidated assets is an appropriate threshold and whether other financial institutions should fall under the definition of a covered institutions.

Implications and Objections

Collectively, the escalation of reporting requirements imposed by the proposal would appear to increase the likelihood of FDIC enforcement actions. The rule passed by a 3-2 vote of the FDIC Board. Each of the two Republican-affiliated Board members (Director McKernan and Vice Chairman Hill) issued a public dissenting statement.

Critics such as Director McKernan have pointed out that certain requirements in the Proposed Standards would exceed, or simply differ from, the Heightened Standards in prescriptiveness and stringency, creating confusion. For example, the FDIC sets its threshold for application ($10 billion or more in consolidated assets) much lower than the Heightened Standards (federally chartered banks with at least $50 billion in consolidated assets). The Proposed Standards also lean toward a rules-based approach to corporate governance, in contrast to the principles-based approach that is prevalent under state law. Critics have asserted that the Proposed Standards are presented as “good corporate governance” without appreciating that what is “good” for one bank may not be “good” for another with FDIC Vice Chairman Hill saying regulators need to resist “one-size-fits-all” best practices.

FDIC Director McKernan also asserted in his dissent that the requirement that the bank board “consider the interests of all its stakeholders, including shareholders, depositors, creditors, customers, regulators, and the public” could be at odds with bank directors’ fiduciary duties under applicable state law, for example, if a director voted against the interests of shareholders in order to serve the interests of customers or the “public.”

As mentioned above, the period for comment was extended to close on February 9, 2024.

What’s in an Acronym? (Or, Can Bill Ackman “SPARC” a Fix to SPACs?)

POMERANTZ MONITOR | NOVEMBER DECEMBER 2023

By Louis C. Ludwig

A recent innovation in the realm of investment vehicles, SPACs, or Special Purpose Acquisition Companies, have experienced a dramatic rise and fall in the past few years. Unlike traditional IPOs, SPACs go public without a business model, later acquiring or merging with an existing company with a defined business. In so doing, SPACs circumvent many of the disclosures required of a traditional IPO. This provides a quicker path to going public, however avoiding the safeguards that the disclosures impose has led to a disturbing string of frauds and scandals. This, in turn, has resulted in SPACs trading for under $10 per share, as well as some companies withdrawing from previously announced SPAC deals, even if they have to pay millions of dollars to the SPAC for backing out. The sense that SPACs are endangered may be what prompted billionaire investor (and former SPAC aficionado) Bill Ackman to step into the arena of SPAC reform. Ackman’s innovation comes in the form of the suspiciously-similar-sounding “SPARC,” or Special Purpose Acquisition Rights Company.  However, the question remains: is this enough to save the SPAC from extinction?  The answer: quite possibly.

SPACs are sometimes referred to as “blank check companies” because they are created for the sole purpose of acquiring another company and taking it public. They recall the 1980s penny stock market where highly speculative stocks sold for less than $5 per share. Most penny stock offerings were similarly made by blank check companies whose stated purposes were to merge with a to-be-identified target. While penny stocks were cheaper than shares sold on reputable exchanges such as the NYSE, the unregulated market on which they were traded was rife with manipulation and outright fraud, subsequently dramatized in classic films like Boiler Room and The Wolf of Wall Street. By 1990, annual investor losses of $2 billion prompted Congress and the SEC to finally regulate the penny stock market through the Securities Enforcement Remedies and Penny Stock Reform Act of 1990 (PSRA) and Rule 419, respectively.

Fortunately for fans of Wild West-style investing, two bankers developed the concept of a SPAC in the 1990s as an end-run around the PSRA and Rule 419. Like the penny stocks of yore, SPACs lack their own business model; initial investors simply have no idea what type of company they will ultimately be investing in. When formed, SPACs usually have an industry in mind, such as mining or software, but no specific acquisition target. The gap between the empty holding company and the entity that ultimately emerges through the SPAC process has led some observers to note that a more accurate term is “SCAMs.”

The typical SPAC timeline is as follows: first, the SPAC’s sponsors, who often possess significant financial and reputational clout, e.g., Martha Stewart and Shaquille O’Neal, provide the starting funds for the SPAC; second, the sponsors, assisted by underwriters, take the SPAC public through a standard IPO, which allows the SPAC to raise funds that are held in a trust, pending identification of an acquisition target; and third, assuming the sponsors identify a target company within 18 to 24 months and obtain shareholder approval, the SPAC merges with the target company in a process known as “De-SPAC-ing.” Once the de-SPAC is complete, the resultant company retains the name and operations of the target company, which then trades publicly on a stock exchange. Shareholders can typically redeem their investment if the 18 to 24-month window lapses and shareholders vote to extend the period for the SPAC to find an acquisition target, or if an acquisition target is found but the shareholders don’t like it.

As the number of SPACs skyrocketed from 2019 into 2021, the informational disadvantage to investors inherent in the penny stock market began to reproduce in the SPAC space. SPACs have raised vast sums selling warrants as part of their IPOs, which can be used to buy shares in the de-SPAC-ed company. In the de-SPAC process, sponsors receive compensation in the form of a large ownership stake for a nominal cost, setting up a textbook conflict of interest. As The D&O Diary’s Kevin LaCroix aptly put it, “[t]he conflict arises from the SPAC sponsor’s financial interest in completing a merger even if the merger is not value-creating, which may conflict with the shareholders’ interest in redeeming their shares if they believe that the proposed merger is disadvantageous.” What’s more, these lucrative sponsor compensation arrangements create dilutive effects affecting investors in the SPAC.

Even where they can show they’ve been wronged, SPAC investors are likely to have the courthouse doors slammed in their faces. Freed from the constraints of a traditional IPO, SPAC operators are permitted to speak directly to the market about the SPAC’s financial prospects. SPAC projections are generally protected by the safe harbor for forward-looking statements afforded by the Private Securities Litigation Reform Act (PSLRA), whereas projections made in connection with traditional IPOs are beyond the PSLRA’s safe harbor.

Almost as soon as SPACs became popular, scandals began to erupt. Nikola and Clover Health Investments, two of the biggest SPACs to go public in 2020, found themselves embroiled in fraud investigations conducted by the SEC and DOJ.  In July 2021, Ackman’s own SPAC, Pershing Square Tontine Holdings, abandoned a deal to buy 10% of Vivendi’s flagship Universal Music Group after the SEC flagged several elements of the deal. According to Ackman, a colorful figure best known for his crusades against Herbalife and Harvard President Claudine Gay, the SEC “said that, in their view, the transaction did not meet the New York Stock Exchange SPAC rules and what that meant was what I would call a dagger in the heart of the transaction.” Ackman was forced to return $4 billion to investors.

In response, the price of Directors and Officers insurance for SPACs was reported to have almost doubled by the end of 2020. Democratic legislators in the U.S. House of Representatives introduced the “Holding SPACs Accountable Act of 2021,” which would have excluded all SPACs from the safe harbor, and the “Protecting Investors from Excessive SPACs Fees Act of 2021,” which would have compelled the SEC to adopt a rule requiring SPACs to disclose compensation arrangements in the interest of transparency. While both pieces of legislation passed the Committee on Financial Services, neither became law. For its part, the SEC has increased its scrutiny of SPACs, tightened disclosure regulations, and clarified that the safe harbor applies only to private litigation action and not SEC enforcement.

After the SEC spiked his SPAC’s Universal deal in mid-2021, Ackman debuted a new take on the faltering investment vehicle, the SPARC. SPARCs do not require up-front money from investors like SPACs do. Instead of shares, SPARCs issue rights. Because the SPARC gives rights away, no money is held in trust. Once the acquisition target is identified, SPARC investors are given the chance to either walk away or opt in. Only if these investors approve the acquisition target and the amount that the SPARC is asking them to fork over (which will vary based on the size of the deal), can the deal close. At this point, the acquisition target gets the money and becomes public, and the SPARC rights transform into shares of the new public company. Importantly, SPARCs do not offer IPO warrants, which are used by SPACs as a way to enhance the capital raised in an IPO. This means that SPARC investors will not be diluted by such warrants and will therefore retain more of the company. Finally, SPARCs will have 10 years to complete an acquisition, in contrast to the 18 to 24-month period typically allocated to SPACs. 

Though the future of the SPARC remains uncertain, it appears to address several of the concerns that have imperiled SPACs. Most prominently, SPARC investors, unlike their SPAC counterparts, have the ability to hold back their investment while they evaluate the target. The increased control granted to SPARC investors also avoids the elimination of the safe harbor, and investors will have a greater chance to probe the specifics of the proposed acquisition. Lastly, SPARCs sidestep the share dilution endemic to SPAC compensation agreements, the precise concern underlying the “Protecting Investors from Excessive SPACs Fees Act of 2021.” The SPARC is accurately characterized as shifting risk from the investor to the sponsor, who must corral investors without the leverage that comes from holding a pool of money in trust. In early October 2023, Ackman announced that he had received SEC approval to use a SPARC to raise a minimum of $1.5 billion from investors for the acquisition of a private company.  Ackman seems to have bet that regulators will be more receptive to a model that simultaneously levels the informational playing field and endows investors with more discretion. Given his early victory in bringing the SPARC to fruition, it’s a wager that may have already begun to pay dividends.

The Future of Item 303-Based 10b-5 Claims

POMERANTZ MONITOR | NOVEMBER DECEMBER 2023

By Elina Rakhlin

A major unresolved question in securities litigation is headed back to the Supreme Court this term.  In Macquarie Infrastructure Corp. v. Moab Partners, L.P., SCOTUS will consider whether failing to disclose information required by Item 303 of the SEC’s Regulation S-K can support a private claim under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5.  For plaintiffs seeking to hold companies accountable for misleading their investors by omitting material information from SEC filings, the stakes could not be higher.

Item 303’s Disclosure Duty and the Absence of a Private Right of Action

Item 303 requires that public companies include a Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) section in their periodic SEC filings.  The MD&A must describe known trends, demands, commitments, events or uncertainties that are reasonably likely to materially impact the company’s financial condition or operating performance.  The SEC has made clear that Item 303 imposes an affirmative duty to disclose material information.  A company violates Item 303 by omitting information about a known trend or uncertainty that investors would consider important.

However, courts have widely recognized there is no private right of action under Item 303 itself—in other words, investors cannot sue directly for a company defendants’ nondisclosures.  Instead, plaintiffs are forced to seek recovery for these Item 303 violations within an existing securities fraud claim that does have a private right of action—most commonly, under Section 10(b) and Rule 10b-5.

This raises a key unsettled question–when does an Item 303 violation form the basis for an omissions case under Section 10(b)?

The Split: Can an Item 303 Violation Support a 10b-5 Claim?

To prevail on a Rule 10b-5 omission claim, plaintiffs must prove (1) the company had a duty to disclose, and (2) the omitted information was material.  All courts agree that violating Item 303 breaches the duty to disclose.  Where they diverge is whether an Item 303 violation, without more, makes the omission material for purposes of 10b-5.

Some circuits have held that Item 303 does not create a Section 10(b) duty to disclose.  The Ninth, Third and Eleventh Circuits have held that just because a trend or uncertainty should be included under Item 303 does not mean that omitting it is a violation of Section 10(b). In their view, an Item 303 violation alone cannot establish a 10b-5 claim.  Even if the omission breached Item 303, plaintiffs must separately prove materiality and scienter under 10b-5’s standards.

The Second Circuit disagrees.  It has held that omitting information required by Item 303 is “indeed an omission that can serve as the basis for a Section 10(b) securities fraud claim.”  Under this theory, violating Item 303 satisfies 10b-5’s materiality element automatically.  Plaintiffs need only adequately allege the other 10b-5 requirements, such as scienter.

This divide is pivotal given the broad consensus among the courts that there is no private right of action under Item 303.  As such, investors must look to Section 10(b) and Rule 10b-5 as one of their only avenues to obtain redress for Item 303 violations.  The Circuit split thus determines whether investors can hold companies liable at all for these omissions. 

This split also formed the basis for the Supreme Court’s 2017 decision to grant review in a case presenting the same question, Leidos Inc. v. Indiana Public Retirement System.  However, the case settled before oral argument.  Macquarie gives the Court an opportunity to finally resolve the split.

The Macquarie Litigation

In Macquarie, plaintiff Moab Partners brought 10b-5 claims against Macquarie Infrastructure and its executives.  Moab alleged that Macquarie concealed the known risk that impending regulatory changes restricting use of “high-sulfur fuel oil” in shipping would materially and adversely impact its storage and transportation business.  Specifically, Moab claimed Macquarie violated Item 303 by failing to disclose in its SEC filings the company’s significant exposure to high-sulfur fuel oil and the risks posed by the new regulations.

The district court dismissed the case, finding Moab failed to sufficiently allege either an Item 303 violation or scienter.  The Second Circuit reversed the district court’s decision.  Critically, it held that Macquarie’s omission of the fuel oil exposure and regulatory risks, in violation of Item 303’s disclosure duty, was sufficient to plead a material omission under 10b-5.  The court also found scienter adequately alleged.

Macquarie’s Petition for Certiorari

Macquarie petitioned the Supreme Court for certiorari on the question of whether the Second Circuit erred in holding that “a failure to make a disclosure required under Item 303 can support a private claim under Section 10(b).”  Macquarie argues that this holding improperly expands liability under 10b-5 beyond what the statute and Court precedent permit. In its view, 10b-5 reaches only “deception”—i.e., misleading statements—not pure omissions of information that Item 303 requires be disclosed. Macquarie contends that the Second Circuit’s decision conflicts with Basic v. Levinson, which held that silence, absent a duty to disclose, is not misleading under 10b-5.  Macquarie argues that Item 303’s more expansive disclosure standards make it ill-suited to support 10b-5 liability, which requires materiality be plead with specificity under the PSLRA.

Macquarie further contends that allowing 10b-5 liability for Item 303 omissions will compel companies to make overly defensive disclosures and spur meritless litigation.  Macquarie claims that the Circuit split causes problematic forum shopping, with plaintiffs disproportionately bringing these claims in the Second Circuit.

Moab Partners’ Opposition

In its opposition brief, Moab first argues that Macquarie’s petition should be denied because the Leidos question is not as important as it once seemed.  It claims the Circuit split has proven “superficial,” with most courts dismissing Item 303-based claims on other grounds, such as immateriality or lack of scienter.

Moab defends the Second Circuit’s position as correctly reflecting 10b-5’s text and the principle that misleading omissions are actionable.  It argues that Item 303 creates a mandatory disclosure duty whose breach can mislead investors.  Moab distinguishes “pure omissions” from “half-truths,” arguing that Macquarie’s affirmative statements in SEC filings (like touting steady performance) also triggered a duty to disclose the Item 303 trend.

Finally, Moab argues that allowing 10b-5 liability for Item 303 omissions does not improperly expand the private right of action.  Plaintiffs must still plead and prove materiality, scienter, and all other 10b-5 elements.  Moab contends the robust 10b-5 requirements appropriately limit these claims.

What’s Next?

On September 29, 2023, the Supreme Court granted certiorari in Macquarie Infrastructure Corp. v. Moab Partners.  The case is currently set for oral argument on January 16, 2024.  For years, federal courts have disagreed on whether failing to make required Item 303 disclosures can support private securities fraud suits under Section 10(b) and Rule 10b-5.  The Supreme Court will likely finally resolve this dispute.

The Second Circuit allows these suits; the Ninth Circuit bars them unless plaintiffs show the omission also made affirmative statements misleading.  The Court cares about uniformity in federal securities laws, and the Second Circuit’s approach impacts markets nationwide; so the stakes are high.

Plaintiffs currently have an easier path bringing Item 303-based claims in the Second Circuit.  To plead such a claim there, plaintiffs must adequately allege: (1) defendants violated Item 303; (2) the omitted information was material; (3) defendants acted with scienter; (4) plaintiffs’ purchase/sale of the securities at issue; (5) plaintiffs’ reliance on the omission; and (6) the omission caused losses. 

The Ninth Circuit imposes more stringent requirements, in which plaintiffs are not only required to sufficiently allege those same elements but also show that defendants’ Item 303 nondisclosures made affirmative statements materially misleading.  This increased burden steers plaintiffs to the Second Circuit whenever possible.

If the Court sides with Macquarie, it will be harder for plaintiffs to hold companies liable for misleading omissions in periodic SEC filings.  Ruling for Moab keeps another tool in investors’ anti-fraud arsenal.  No matter the outcome, plaintiffs likely must meet heightened pleading standards for these claims going forward.  If the Supreme Court permits Item 303-based suits under 10b-5, plaintiffs still must rigorously allege facts supporting each element—especially materiality, scienter, and the PSLRA’s particularity mandate.  If the Court bars these suits absent misleading affirmative statements, the path forward is harder still.  Indeed, significant unknowns exist regarding the future of Item 303-based claims as the Court could impose greater requirements on investors seeking to bring these claims or issue a decision that produces more confusion than clarity, leaving the question open to further interpretation and differing applications of the law among the lower courts.  Either way, more vigorous pleading and tighter case screening is the future for Item 303-based 10b-5 actions.

Pomerantz Prevails Against Motion to Dismiss Its SPAC Litigation

POMERANTZ MONITOR | JULY AUGUST 2023

By Tamar Weinrib

Pomerantz, as sole lead counsel, recently won an important victory for investors in a securities fraud litigation against PureCycle Technologies, Inc., certain of its executives (collectively, the “PureCycle Defendants”), and Byron Roth. On June 15, 2023, Judge Byron of the Middle District of Florida denied defendants’ two motions to dismiss the Sections 10(b), 14(a), and 20(as) claims set forth in plaintiffs’ Second Amended Complaint, as well as defendants’ motion to strike, only dismissing the claims as to one of the five individual defendants.

PureCycle is a plastic recycling company that went public via a “de-SPAC” reverse merger with Roth CH Acquisition I Co., a special purpose acquisition company (“SPAC”). SPACs are shell companies set up solely to raise money through an IPO to eventually acquire another company. PureCycle had the dubious honor of being merely one in a long line of questionable reverse mergers Byron Roth has brought public, while misleading investors regarding the underlying business, only to slap a “buy” rating on the stock and collect millions in compensation, leaving innocent investors to suffer the consequences.

To date, PureCycle has never earned any revenue and has only one product -- a process it claimed could cost effectively recycle polypropylene, a common plastic that, since its invention in 1951, has stymied all efforts of the top scientists and chemical companies researching a way to effectively or economically recycle it. As the Court how now twice ruled (in the June 15, 2023 order and a previous order granting defendants’ motion to dismiss the First Amended Complaint in part), the PureCycle Defendants and Roth issued false and misleading statements throughout the November 16, 2020 - November 10, 2021 Class Period, claiming to have achieved the impossible. Specifically, defendants represented in proxy statements, a registration statement, and in press releases, that their recycling process is “proven” to convert waste polypropylene (called feedstock) into virgin polypropylene resin more cost effectively than manufacturing virgin polypropylene traditionally and utilizing a broader range of feedstock than traditional recycling. In reality (as multiple industry experts have attested), the technology underlying the process is unproven, presented serious issues at lab scale, could not be achieved cost effectively, and could not utilize a broader range of feedstock than traditional recycling. Defendants further touted the PureCycle management team -- which claimed to have solved the previously unsolvable polypropylene recycling problem -- as having “broad experience across plastics,” and decades of experience scaling early-stage companies in public markets and leading transformational projects, though they in fact had no background in plastics recycling and previously brought six other early-stage companies public that subsequently imploded, causing substantial investor losses. In the order, the Court held, “Defendants have failed to present any new argument that would cause the Court to reverse what it has already determined.”

The Court further held that plaintiffs sufficiently alleged scienter (a culpable state of mind) for purposes of the § 10(b) claim (the sole basis for the Court’s prior partial grant of defendants’ motion to dismiss the First Amended Complaint); Section 14(a), which is based on false and misleading statements in the proxy statements, does not require scienter. With regard to the PureCycle Defendants, the Court found scienter because the Second Amended Complaint avers with “greater specificity…the repeated instances wherein Defendants collectively and individually flaunted their past experience without disclosing their alleged prior business failings.” The Court reached this conclusion for two reasons: 1) the “shift in phrasing” demonstrating that “each Defendant individually ‘acted with the required state of mind’ by touting his own experience while omitting previous failures,” and 2) “Plaintiffs more precisely emphasize the repeated manner in which Defendants touted their experience.”

Though not determinative on its own, the Court also noted the PureCycle Defendants’ repeated “willingness to bolster their own credibility” as compared to their utter silence when their credibility was attacked in the short seller report that revealed the fraud in this case at the end of the Class Period, causing PureCycle’s stock to plummet 40%. As part of its holistic analysis, the Court also based its scienter ruling on defendants’ significant financial gain from the SPAC merger, access to internal company information, lack of experience with polypropylene recycling, and an SEC investigation that commenced in September 2021 “pertaining to, among other things, statements in connection with PureCycle’s technology, financial projections, key supply agreements and management.”

With regard to defendant Roth, the Court correctly rejected his piecemeal attacks and found scienter based on his “checkered history,” financial motive to act fraudulently, the “core operations” doctrine, Roth’s signing of the S-4, Schedule 14A (which contained the SPAC merger agreement), including the initial Proxy Statement and then later the amended Proxy Statement for Special Meeting of Stockholders of Roth Acquisition with the SEC which showed his “ongoing involvement with the SPAC merger over a period of several [pivotal] months,” and his access to information during that time including the “personnel, books, records, properties, financial statements, internal and external audit reports, regulatory reports, Contracts, Permits, commitments and any other reasonably requested documents and other information of [PureCycle Inc.], when Roth issued his misstatements.”

Defendants filed a motion on June 30, 2023 asking the Court to reconsider its order, claiming that “recent developments,” i.e., that PureCycle’s first plant just started producing “post-industrial recycled pellets” undermine plaintiffs claim. However, as plaintiffs argued in an opposition brief filed on July 14, 2023, the misleading statements set forth in the Second Amended Complaint pertained to the status of PureCycle’s technology almost two years ago, not the status of its technology today. Moreover, the misstatements concerned defendants’ claims that PureCycle could recycle polypropylene into virgin-like resin, more cost effectively than traditional recycling methods, and using a broader range of feedstock than traditional recycling. Defendants have not introduced a single fact to suggest that these recently produced pellets are virgin-like, produced more cost effectively than traditional recycling methods, or using a broader range of feedstock. In fact, less than a year ago, the FDA told PureCycle that it could only recycle polypropylene into packaging for food and drink as long as the feedstock comes solely from drink cups, the antithesis of a broad range. Defendants alternatively argued that the Court committed legal error in its scienter ruling, relying on new arguments they did not raise in their motions to dismiss (and thus are foreclosed from arguing now) and basing their arguments on mischaracterizations of the Order.

The discovery process is set to begin, and plaintiffs will file their motion for class certification in the coming months.

The Questionable Use of Free Speech Defenses in Securities Litigation

POMERANTZ MONITOR | JULY AUGUST 2023

By Villi Shteyn

Corporate actors trying to evade liability for fraud have used some questionable defenses, but the least credible may be trying to hide behind the First Amendment of the United States Constitution under the banner of free speech. The Supreme Court has stated that “the First Amendment does not shield fraud,” but that has not stopped companies from trying. This sets the backdrop for Massachusetts Attorney General Maury Healey’s suit against ExxonMobil Corp. (“Exxon”) brought in Massachusetts State Court back in October 2019.

The suit included claims that oil giant Exxon lied to consumers by marketing its products as environmentally friendly and, importantly, that Exxon misled investors by downplaying any climate-driven financial risks to its bottom-line financials. Specifically, the suit alleged that in the past, Exxon’s former CEO stated that the scientific evidence on climate change is inconclusive, as part of a campaign by Exxon to deceive consumers and investors despite decades-long internal knowledge to the contrary. The suit claims that Exxon more recently tells investors that climate change risks are a management priority, but its financial projections continue to deceive investors by asserting that virtually none of Exxon’s fossil fuel assets will be at risk. The complaint details how Exxon has internally analyzed and known these risks for over forty years but has failed to disclose them to investors. Instead, while publicly stating that the company accounted for climate change-related risks in its business planning, Exxon actually grossly undercounted such risks in its financials.

Exxon tried to claim that these statements, rather than being targeted to investors, were merely Exxon’s participation in the public discourse on a controversial issue of public concern and were directed at lawmakers or the public. This is despite the fact that examples included the statement that Exxon will “face virtually no meaningful transition risks from climate change.”

In a ruling issued last year, the Massachusetts Supreme Judicial Court rejected Exxon’s First Amendment defense to Attorney General Healey’s suit. The Court largely ignored the substance of the argument and simply found that Massachusetts’ anti-Strategic Lawsuit Against Public Participation (“anti-SLAPP”) law did not apply to civil enforcement proceedings brought by the state’s Attorney General, and that it was instead meant to block lawsuits brought by private actors. This ruling may leave private securities litigants wanting, but the Court did specify that the legislative history for the anti-SLAPP statute was meant “especially” for developers attempting to prevent local opposition to zoning approval.

Also, in positive news for investors, recent developments in the case law have shown courts to be highly skeptical and unconvinced by First Amendment defenses.

Ohio-based electrical utility company FirstEnergy Corp. also tried an extremely craven First Amendment defense in an investor class action. In a 2022 opinion, Chief Judge Marbley of the Southern District of Ohio found FirstEnergy’s First Amendment defense to strain[] credibility.” FirstEnergy attempted to argue, in a manner similar to Exxon, that corporations have a First Amendment right to speak on issues of public importance. But in this case, the supposedly protected statements were bribes. Specifically, this argument was made in the face of allegations of political contributions through the use of 501(c)(4) entities that were bribes to corrupt politicians and regulators. The court rejected this nonsensical argument and found that the bribery payments and deception of investors about the nature of the political activity undertaken by the company were not protected speech.

Similar First Amendment challenges have also failed in other securities fraud class actions, such as in a 2021 opinion in Pomerantz’s action in the Altria and JUUL securities fraud litigation in the Eastern District of Virginia. There, the court rejected use of the Noerr-Pennington doctrine for protections of petitioning activity because “the First Amendment offers no protection when petitioning activity ... is a mere sham to cover an attempt to violate federal law[,]” and fraud allegations under the Exchange Act raise this sham exception. A 2020 Northern District of California Court found similarly, despite the speech in question being a letter to Congress.

Judge Liman of the Southern District of New York issued a 2022 opinion equally unconvinced of this type of defense. In 2018, Tesla CEO Elon Musk agreed to a consent decree with the Securities and Exchange Commission (“SEC”) in the wake of settling charges by the SEC under the Exchange Act for false and misleading statements. The consent decree prevents him from communicating about Tesla without pre-approval by Tesla, to ensure the accuracy of the statements and consistency with what Tesla reports. In an attempt to terminate the consent decree, Musk argued that his First Amendment rights were intruded upon. However, Judge Liman found this argument wholly unconvincing and stated that Musk’s free speech rights do not allow him to engage in speech that is fraudulent or otherwise violates the securities laws. Judge Liman further found that the consent decree waived any First Amendment rights implicated. This decision was appealed to the Second Circuit of Appeals. The Second Circuit was no more receptive to the First Amendment argument and affirmed Judge Liman’s decision in a summary order.

Pomerantz has also had success in litigating a case involving statements relating to climate preparedness. In Vataj v. Johnson, settled favorably on behalf of defrauded investors in 2021, plaintiffs alleged false and misleading statements regarding a utility’s preparation and risk-minimization for wildfires.

            Thus, courts still view these dishonest First Amendment protections for what they are: pretextual rationalizations to try to evade liability for deceiving investors. It is well-settled law that the First Amendment does not protect fraud, and courts are unlikely to prevent investors from enforcing their rights to be protected from false and misleading statements under the false guise of free speech. While securities fraud defendants will certainly continue to use questionable tactics to attempt to shield themselves from liability for false or misleading statements, courts’ patience with these attempts, especially with the attempted use of the First Amendment, is wearing thin.

Navigating Section 220 Demand for Corporate Books and Records

POMERANTZ MONITOR | JULY AUGUST 2023

By Ankita Sangwan

Section 220 of the Delaware General Corporation Law (“Section 220”) grants shareholders the right to access corporate books and records, provided they fulfil the necessary “form and manner” requirements specified in the statute, and provided the demand is in furtherance of a “proper purpose.” Per Section 220, a proper purpose is one that is “reasonably related” to the shareholder’s interest as a shareholder. Most commonly, shareholders use Section 220 to investigate potential corporate misconduct, such as breaches of fiduciary duty by directors or officers, cases of mismanagement, corporate waste, or other wrongdoing, all of which have been recognized as “proper purposes” by Delaware courts. 

To proceed, a stockholder must demonstrate a “credible basis” for suspecting wrongdoing or mismanagement, which is the “lowest possible” burden of proof under Delaware law. While mere speculation, curiosity, and suspicions do not satisfy it, the threshold is satisfied through documents, logic, testimony, or otherwise demonstrating that there may be legitimate issues of wrongdoing or mismanagement. Further, the Delaware Supreme Court has affirmed that “where a stockholder meets this low burden of proof … [the] stockholder’s purpose will be deemed proper under Delaware Law” and that the stockholder “is not required to specify the ends to which it might use the books and records.” Thus, a stockholder is not required to demonstrate that the suspected wrongdoing it seeks to investigate is “actionable” under Delaware law. Once a stockholder establishes proper purpose and credible basis, they are entitled to access the relevant corporate books and records that are considered “necessary” to investigate the specific wrongdoing that the stockholder has identified in their Section 220 Request.

The Delaware Court of Chancery has encouraged stockholders to avail themselves of the ‘tools at hand’ and request company books and records before filing derivative complaints and has admonished plaintiffs when they have not attempted to gather reasonable information to substantiate their allegations before filing a derivative complaint. Section 220 has thus become a popular and widely used tool for stockholders seeking to investigate corporate wrongdoing and mismanagement. This wide usage of Section 220 has led to an evolution of Delaware’s jurisprudence reflecting judicial efforts to maintain a balance between the rights of stockholders to obtain information based on credible allegations of corporate wrongdoing and the rights of corporations to manage their business without undue interference from stockholders. The “credible basis” standard forms part of judicial efforts to maintain this balance. Courts have thus ruled against plaintiffs where investigations are deemed to be “indiscriminate fishing expeditions," and thus adverse to the interests of the corporation.

In “The Paradox of Delaware’s ‘Tools at Hand’ Doctrine: An Empirical Investigation,” published by Duke University School of Law in 2019, James D. Cox, Kenneth J. Martin, and Randall S. Thomas state that the results of their study “support[s] the positive social benefits of Delaware’s innovative tools at hand doctrine.” In recent years, they found, a trend emerged with defendants increasingly treating Section 220 actions as a “surrogate proceeding to litigate the possible merits of the suit” and to “place obstacles in the plaintiffs’ way to obstruct them from employing it as a quick and easy pre-filing discovery tool.” Courts have reprimanded corporations that use such “overly aggressive” litigation tactics while responding to Section 220 demands. Pomerantz has successfully litigated against such defense campaigns by different corporations. In a case filed against Biogen where plaintiff sought to investigate potential corporate wrongdoing and mismanagement arising from a federal investigation and a former employee’s allegations in a wrongful termination suit, the Delaware Court of Chancery noted that Biogen followed “the recent trend in adopting what has been referred to as an “overly aggressive defense strategy” in opposing inspection and granted plaintiffs access to board-level materials.

In another instance, Pomerantz, along with two other firms, filed a complaint against Gilead, when Gilead employed similarly aggressive strategies against plalintiffs’ Section 220 demands. The purpose of these demands was to investigate possible wrongdoings concerning the production, marketing and sales of Gilead’s HIV drugs. In her decision, Chancellor McCormick (Vice Chancellor at the time) noted that “Gilead exemplified the trend of overly aggressive litigation strategies by blocking legitimate discovery, misrepresenting the record, and taking positions for no apparent purpose other than obstructing the exercise of Plaintiffs’ statutory rights.” Chancellor McCormick also found that Gilead’s approach called for fee-shifting since Gilead had engaged in bad faith conduct. Ultimately, defendants were sanctioned and ordered to pay Pomerantz and other plaintiffs’ counsel $1.76 million in attorney’s fees.

Another emerging trend is that stockholders are using Section 220 demands to investigate a company’s commitments to diversity and other ESG concerns. In Asbestos Workers Phila. Welfare & Pension Fund v. Scharf, No. 3:23-cv-1168 (N.D. Cal. Mar. 15, 2023), shareholders relied on information and documents received pursuant to a Section 220 demand to allege that the Wells Fargo Board disregarded “pervasive issues of discrimination” and further alleged that the bank conducted fake interviews with minority candidates. Similarly, a Tesla stockholder relied on Section 220 documents to allege that the Tesla Board fostered a company culture of tolerating sexual harassment and racial discrimination.

In a recent case on this issue, Simeone v. The Walt Disney Company (Del. Ch. June 27, 2023), the Delaware Court of Chancery rejected an action filed by a Walt Disney stockholder seeking to compel inspection of books and records relating to the company’s opposition to Florida’s “don’t say gay” law – in a stance that allegedly caused Florida’s Governor and state legislature to retaliate against the company by stripping it of special state-granted tax treatment and other benefits. In ruling against the stockholder, the Court held that he had not established a proper purpose for his Section 220 demand because the stated purpose belonged to the stockholder’s counsel, rather than to the stockholder himself. The stockholder testified that he had been solicited to make the Section 220 demand and had been put in touch with the Thomas More Society, a “public interest law firm championing Life, Family, and Freedom.” He also testified that his only purpose in requesting inspection was to “know the person or persons who were responsible for making th[e] political decision at Disney to publicly oppose” the law. The Court also held that  “[t]he plaintiff is not describing potential wrongdoing.  He is critiquing a business decision.  A stockholder cannot obtain books and records simply because the stockholder disagrees with a board decision, even if the decision turned out poorly in hindsight.” The Court further explained that a corporation’s “choosing to speak (or not speak) on public policy issues is an ordinary business decision,” even if the topic is a “divisive” one, and even if it is “external to [the company’s] business.” The Court concluded that “At bottom, the plaintiff disagrees with Disney’s opposition to [the Florida law]. He has every right to do so. But disagreement with [a] business judgment is not evidence of wrongdoing warranting a Section 220 inspection.”

The Walt Disney case differs from the other decisions and is interesting for several reasons, one being that it focuses on the stockholder’s – not their lawyers’ – purpose, and emphasizes that even if an alleged bad corporate decision has been made, it does not necessarily mean that a wrongdoing at the level of a breach of fiduciary duty occurred. Delaware Courts have consistently emphasized that “bad” or “misguided” business decisions that do not involve legal violations typically do not qualify as breaches of fiduciary duty. Furthermore, there have been discussions among courts and experts questioning whether such decisions can be considered breaches of fiduciary duty if they are not connected to any legal violations. In any event, these spates of decisions highlight the growing trend of ESG-related litigation, which continues to be bolstered by Section 220 requests.

Given the popularity of Section 220 requests and their usefulness in investigation of corporate wrongdoings, it will be interesting to see how these trends develop and evolve.

SCOTUS Decision Endorses Pomerantz Evidence Standard

POMERANTZ MONITOR | JULY AUGUST 2021

Pomerantz Partner Emma Gilmore led a team of Pomerantz attorneys and twenty-seven of the foremost evidence scholars to submit an amicus brief to the Supreme Court of the United States in Goldman Sachs Group, Inc. et al v. Arkansas Teachers Retirement System, et al. (No. 20- 222). Pomerantz’s brief was the sole amicus brief devoted to one of only two issues before the Court: whether the defendants in securities fraud class actions bear the burden of persuasion when seeking to rebut the presumption of reliance originated by the Court in its landmark decision in Basic, Inc. v. Levinson, or whether the defendants bear only the lower burden of production, as Goldman Sachs argued. On June 21, 2021, the Supreme Court held, in a 6-3 decision, that the defendants bear the ultimate burden of persuasion in rebutting the Basic presumption. In so holding, the Court adopted the arguments asserted by Pomerantz and the law professors in their amicus brief.

To state a claim for securities fraud, a plaintiff must establish that she relied on a misrepresentation or omission when she bought or sold securities. The misrepresentation or omission artificially inflates a security’s price until the statement’s false or misleading nature is disclosed — at which point, the stock price falls, harming investors. If each plaintiff bringing securities fraud claims had to prove individual reliance on a specific misrepresentation, however, it would be virtually impossible to bring securities fraud claims as class actions, because each plaintiff would need to individually demonstrate how she relied on the misrepresentation when she bought or sold securities. In Basic, however, the Supreme Court held that securities fraud plaintiffs can invoke a presumption that they relied on a misrepresentation in buying or selling securities because, in an efficient market, the price of a security reflects all the company’s material public statements, including false or misleading statements. The “fraud on the market” presumption of reliance the Supreme Court established in Basic thus obviated the need for each member of a class to show reliance on a case-by-case basis, enabling securities fraud lawsuits to proceed as class actions.

To invoke the Basic presumption, a plaintiff must prove that (1) an alleged misrepresentation was publicly known; (2) it was material (i.e., significant to a “reasonable investor”); (3) the security traded in an efficient market; and (4) the plaintiff traded the security between the time the misrepresentation was made and when the truth was revealed. Once a plaintiff has established these four elements, all similarly situated class members are presumed to have relied upon the misrepresentation in deciding whether to buy or sell the security.

A defendant can rebut this presumption, however, by producing evidence reflecting that the alleged misrepresentation did not affect the price of the security.

Pomerantz’s amicus brief argued that defendants bore the heavier burden of persuasion:

Basic made clear that to overcome the presumption of reliance, defendants must actually “sever the link” between the alleged misrepresentation and the price of the security. 485 U.S. at 248. Halliburton II reaffirmed this holding and suggested that “sever[ing] the link” would require defendants to adduce “more salient” evidence than the plaintiffs. 573 U.S. at 282. Thus, the language of Basic and Halliburton II, together with their focus on advancing Congress’s intent, show that the Court imposed on defendants the burden of persuasion, and not just a burden of production, to rebut the presumption.

Goldman argued that Federal Rule of Evidence 301 places the burden of persuasion on plaintiffs. Rule 301 states that while “the party against whom a presumption is directed has the burden of producing evidence to rebut the presumption,” this “does not shift the burden of persuasion, which remains on the party who had it originally.” Therefore, Goldman argued, defendants need only produce some evidence of no price impact, leaving plaintiffs with the ultimate burden of persuasion.

Pomerantz’s amicus brief, however, argued that (i) courts have the ability to reassign the burden of persuasion to any party regardless of Rule 301, and (ii) the Supreme Court’s prior decisions had assigned to defendants the burden of persuasion with regard to the presumption of reliance. Pomerantz’s amicus brief argued that:

Courts and commentators alike have understood that when necessary to satisfy the demands of the substantive law being applied—including “statutory policy”—courts may diverge from Rule 301’s default rule and allocate the burden of persuasion to the opposing party. Indeed, this Court has declared that Rule 301 “in no way restricts the authority of a court or an agency to change the customary burdens of persuasion in a manner that otherwise would be permissible” (citations omitted).

The brief explained that the language in prior Supreme Court decisions reflected the Court’s intent to assign the burden of persuasion to defendants:

This Court’s decisions in Basic and Halliburton II [Halliburton Co. v. Erica P. John Fund, Inc., 573 U.S. 258 (2014)] reflect precisely this sort of consideration of substantive law of a statute—here section 10(b) of the Securities Act—in both creating the Basic presumption and assigning the burden of persuasion to defendants to rebut it. Thus, the statute and its substantive law apply, not the generally applicable Rule 301.

The Supreme Court adopted Pomerantz’s and the evidence scholars’ arguments. The Court began its analysis by observing that:

We have held that Rule 301 “in no way restricts the authority of a court ... to change the customary burdens of persuasion” pursuant to a federal statute. NLRB v. Transportation Management Corp., 462 U. S. 393, 404, n. 7 (1983). And we have at times exercised that authority to reassign the burden of persuasion to the defendant upon a prima facie showing by the plaintiff. See, e.g., Teamsters v. United States, 431 U. S. 324, 359, and n. 45 (1977); Franks v. Bowman Transp. Co., 424 U. S. 747, 772– 773 (1976).

The Court then held that, as Pomerantz and the law professors argued, Basic and Halliburton II did allocate the burden of persuasion to defendants:

Basic held that defendants may rebut the presumption of reliance if they “show that the misrepresentation in fact did not lead to a distortion of price.” 485 U. S., at 248 (emphasis added). To do so, Basic said, defendants may make “[a]ny showing that severs the link between the alleged misrepresentation and ... the price received (or paid) by the plaintiff.” Ibid. (emphasis added). Similarly, Halliburton II held that defendants may rebut the Basic presumption at class certification “by showing ... that the particular misrepresentation at issue did not affect the stock’s market price.” 573 U. S., at 279 (emphasis added).

***
Thus, the best reading of our precedents ... is that the defendant bears the burden of persuasion to prove a lack of price impact.

Notably, in so holding, the Supreme Court cited with approval the Second Circuit’s ruling in Waggoner v. Barclays PLC, 875 F. 3d 79, 99–104 (2d Cir. 2017) that the phrase ‘[a]ny showing that severs the link’ aligns more logically with imposing a burden of persuasion rather than a burden of production.” Pomerantz successfully prosecuted the claims in Barclays, spearheading a similar amicus brief on behalf of numerous leading evidence scholars.

Pomerantz’s and the amicus professors’ win in the Supreme Court ensures that aggrieved investors can continue to aggregate their claims as a class against companies that defraud them.

Emma Gilmore stated, “The Supreme Court’s decision is a significant victory for plaintiffs and against defendants seeking to demolish the presumption of reliance that has allowed aggrieved investors to pursue securities act violations as a class. Twenty-seven of the foremost evidence scholars in the United States backed our position; not a single one backed the defendants’. This important win paves the ground for more victories on behalf of defrauded investors.”

Plaintiff Takeaways from High Court’s Goldman Ruling

POMERANTZ MONITOR | JULY AUGUST 2021

On June 22, 2021, in Goldman Sachs Group Inc. v. Arkansas Teacher Retirement System, the United States Supreme Court rendered a decision critical to the future of federal securities fraud class actions. In a July 2 article in Law360, Marc I. Gross and Jeremy A. Lieberman analyzed what that means for the plaintiffs’ bar. The following is an abbreviated recap of their analysis.

The Court held that in determining whether allegedly misleading statements impacted stock prices, (1) a court should consider the “generic nature” of the statements by way of expert opinion, other empirical evidence and “common sense”; and (2) defendants bear the burden of persuasion to demonstrate that the statements had no impact on market prices.

While defendants have framed the holding on the first point as a big win for their bar, Marc and Jeremy beg to differ. [Eds: For a discussion of the second point, see this issue’s article on Pomerantz’s amicus brief.]

The generic nature of statements has often been considered at the motion-to-dismiss and class stages. What the Supreme Court made clear, though, was that the generic nature of statements did not render them per se unworthy of class certification, but rather, it is one factor to be weighed along with empirical evidence and expert testimony regarding actual price impact.

A central element of securities fraud claims is proof that investors relied upon allegedly misleading statements when purchasing shares. Following the 1966 adoption of Rule 23 in the Federal Rules of Civil Procedure, courts wrestled with how to prove reliance on a basis common to all class members. If each investor had to prove they actually read the misstatement, individual issues of proof would predominate, rendering securities fraud class actions unmanageable.

The concept that defendants’ misrepresentations create a fraud on the market was first developed by Abe Pomerantz, pioneer of shareholder rights litigation and founder of Pomerantz LLP, in the 1970 case, Herbst v. Able. Thereafter, courts recognized that if companies inflated their reported earnings, the stock market price of their securities would likely be inflated as well, thereby causing all investors to be defrauded.

In 1988, the Supreme Court embraced this concept in Basic Inc. v. Levinson, formalizing a “presumption” of reliance where stocks were traded in “efficient” markets, i.e., markets that rapidly priced all public information (including misinformation).

Basic also held that the presumption could be rebutted if individual investors relied on nonpublic information. The Supreme Court revisited this presumption in 2014’s Halliburton Co. v. Erica P. John Fund Inc. decision. While reaffirming the presumption’s viability, the court expanded the grounds for its rebuttal. Defendants could also cite evidence demonstrating that the misleading statements had no impact on the stock price.

The dispute in Goldman arose over market impact, or lack thereof, of statements by Goldman representing that the investment bank had “extensive procedures and controls that are designed to identify and address conflicts of interest” and that “integrity and honesty are at the heart of our business.”

The plaintiffs argued that these statements were materially misleading, citing revelations that Goldman had assembled a portfolio of mortgage-backed securities for the benefit of a short-seller, without disclosing this to Goldman clients to whom the bank sold the portfolios and who lost billions of dollars in the 2008 Great Recession. The SEC fined Goldman $550 million for its misconduct.

Goldman moved to dismiss the lawsuit, arguing that its statements were too generic and aspirational to warrant reliance. The U.S. District Court for the Southern District of New York denied the motion in 2012.

At the class motion stage, Goldman again argued that the generic nature of the statements had no market price impact, focusing on the absence of any price change when the statements were issued, nor when journalists questioned the company’s actual client conflict practices.

The plaintiff countered that Goldman had consistently denied any wrongdoing and that its misleading statements effectively maintained the price of Goldman shares until the truth was revealed, causing analysts to question the investment bank’s reputation and the stock price to crater.

The district court twice found that defendants failed to show that the Goldman stock price was not impacted by the misstatements. The U.S. Court of Appeals for the Second Circuit agreed twice. However, in the second decision, U.S. Circuit Judge Richard Sullivan dissented, asserting:

The obvious explanation for why the share price didn’t move after 36 separate news stories on the subject of Goldman’s conflicts is that no reasonable investor would have attached any significance to the generic statements on which Plaintiffs’ claims are based.

The majority retorted:

What the dissent really wants to do is to revisit the question of whether the statements are too general as a matter of law to be deemed material.

Goldman sought certiorari based on Judge Sullivan’s dissent, though its opening brief did not embrace his per se analysis, pivoting instead to the argument that generic nature is just one factor considered in determining price impact. Plaintiffs thus had no reason to disagree.

In her opinion on this issue, in which all the justices joined, Justice Barrett held that, in determining the price impact of generic statements, courts “should be open to all probative evidence on that question — qualitative as well as quantitative — aided by a good dose of common sense,” regardless of whether the issue overlapped with questions of materiality.

Critical to going forward is Justice Barrett’s observation that there may be a “mismatch between the contents of the misrepresentation and the corrective disclosure.” The Court suggested that this could occur where the earlier misstatement was very broad (e.g., “We have faith in our business model”), while the later corrective statement is specific (e.g., “Our fourth quarter earnings did not meet expectations”).

Frankly, both statements are generic and arguably a mismatch, since nothing in the prior statement targeted specific earnings growth. In contrast, in Goldman, the company stated it had strong procedures to prevent conflict of interests, yet those procedures had been flaunted.

Undoubtedly, class certification motions will now shift to battles over the degree to which misstatements and corrective disclosures match.

Courts have recognized that corrective disclosure need not be the “mirror image” of the alleged misrepresentation. Plaintiffs will likely argue that a sufficient degree of overlap in the before and after statements, coupled with empirical evidence (such as analysts’ interpretation of the corrective statements), should suffice to support certification. This will leave for later determination the degree to which the post-corrective stock price decline can be linked to the prior misstatement — an issue that experts often sort out through confounded event analysis.

Also relevant to the evaluation of price impact of such generic statements is their context; e.g., whether the generic statement was intended to distinguish the company from its own prior misconduct or that of its peers.

Plaintiffs will also likely argue that in assessing price impact, courts should consider not just what defendants said, but what they omitted. It is well settled, as expressed by the Second Circuit in 2016’s In re: Vivendi SA Securities Litigation, that “once a company speaks on an issue or topic, there is a duty to tell the whole truth, even when there is no existing independent duty to disclose information” on the matter.

In other words, having opted to burnish its corporate image by professing its integrity and internal control procedures to prevent conflicts, Goldman was arguably duty bound to disclose all related material information lest investors be misled by the omission thereof, including the risk that it had departed from that professed policy. Had Goldman acknowledged such departures, its stock price would likely have declined much earlier than it did.

Finally, courts will need to wrestle with just what is generic and what is meaningful in the minds of investors. This determination has often rested on the courts’ intuitive conception of a reasonable investor. Empirical studies have demonstrated that investors place considerable stock in the perception of management’s integrity and reliability, and that a substantial portion of a company’s market value is a function of that reputation, which such generic statements serve to burnish.

If such generic statements were intended to reassure investors of the company’s reliability and integrity, plaintiffs may well argue that such statements maintained the premium that investors were willing to pay for a company’s strong reputation. This arguably should bear upon class certification of generic statements, as well as their actionability at the pleading stage.

You may read Marc and Jeremy’s entire article on Law360.

Court Rebuffs Activist on Forced Arbitration Provisions

POMERANTZ MONITOR | JULY AUGUST 2021

By Michael Grunfeld

Johnson & Johnson (“J&J”) has been involved since March 2019 in litigation against a small shareholder represented by Professor Hal S. Scott, the Director of the Program on International Financial Systems at Harvard Law School. Professor Scott is seeking to have J&J shareholders vote on a proxy proposal instituting a corporate bylaw that would require all securities fraud claims against the company to be pursued through mandatory arbitration, and that would waive shareholders’ rights to bring securities class actions. The litigation arose after J&J rejected the proposal because it would be contrary to New Jersey law. Professor Scott then decided to file an action in Federal District Court in New Jersey contesting J&J’s rejection, in an action called The Doris Behr 2012 Irrevocable Trust v. Johnson & Johnson. Pomerantz has been involved in the litigation on behalf of the Colorado Public Employees’ Retirement Association (“Colorado PERA”), as an intervenor seeking to ensure that investors’ rights are protected.

On June 30, 2021, Judge Michael A. Shipp of the United States District Court for the District of New Jersey handed down an important victory for shareholders when it granted J&J’s and the Intervenors’ Motion to Dismiss. This decision was the result of several years of legal maneuvering. First, on April 8, 2019, the court denied Professor Scott’s motion for an order compelling J&J to include the proposal in its proxy for its 2019 shareholder meeting because he acted too late for that year. Then, after Professor Scott filed an amended complaint on May 21, 2020, J&J informed him, apparently to avoid further litigation, that if he were to properly submit his shareholder proposal for inclusion in the company’s 2021 proxy materials, the company would include it and allow its shareholders to vote on the proposal at J&J’s 2021 annual meeting.

Rather than take J&J up on its offer, which would have allowed Professor Scott to achieve his purported goal of having J&J’s shareholders decide on whether they actually want his proposed forced arbitration provision, Professor Scott continued with his litigation. As J&J explained in its motion to dismiss:

Given the Company’s agreement to include the Proposal in the 2021 Proxy Materials, there is no reason to continue to litigate this action. The only explanation for Plaintiff’s refusal to voluntarily dismiss this action is Plaintiff’s trustee’s academic interest in obtaining a judicial decision on the validity of mandatory arbitration bylaws—a crusade that Plaintiff’s trustee has pursued for years. But it is well-established that this Court cannot issue an academic decision that would amount to no more than a hypothetical advisory opinion.

The Court agreed. Judge Shipp explained in his decision granting the motion to dismiss that plaintiffs’ request for declaratory relief as to the past proxy materials is moot because the time for that proposal has passed. The Court also ruled that plaintiffs’ request for declaratory relief as to potential future proxy proposals is not ripe because it is “too hypothetical at this juncture and contingent on future events.” This is because the plaintiffs “fail[ed] to identify any specific shareholder meeting for which they ‘wish’ to resubmit the proposal, let alone the next shareholder meeting in 2022,” as well as the fact that J&J informed plaintiffs that the company “will no longer exclude the Trust’s proposal from its annual proxy materials.” The Court therefore also determined that it could not issue an opinion as to whether the Proxy Proposal is permitted under New Jersey law, because such a ruling “would amount to an advisory opinion.” Federal courts may not issue advisory opinions because they “may not decide questions that cannot affect the rights of litigations in the case before them or give opinions advising what the law would be upon a hypothetical state of facts.”

The court allowed plaintiffs a final opportunity to amend their complaint. Plaintiffs filed an amended complaint on July 13, 2021, stating that they plan to resubmit their shareholder proposal for consideration at Johnson & Johnson’s 2022 annual shareholder meeting, and seek a declaratory judgment as to the legality of the proposal. The litigation will therefore continue for the time being and Pomerantz will continue to ensure that the interests of shareholders are represented therein.

This litigation raises the critical right of shareholders to bring securities class actions in court rather than being forced into arbitration proceedings that would preclude shareholders’ ability to band together as a class. These rights are essential for shareholders to be able to seek recovery, and hold companies accountable, for securities fraud for several important reasons. One is that it would otherwise be prohibitively costly and difficult for most investors to bring claims on an individual basis. Moreover, in addition to allowing individual investors to seek redress, the availability of securities class actions provides the market and investors with an important prophylactic mechanism that deters companies and their executives from committing securities fraud. The transparency and accountability of the public court system, as opposed to the private and closed nature of arbitration, is essential for these protections to function properly.

Historically, the Securities and Exchange Commission (“SEC”) has opposed proposals to mandate arbitration of securities claims. The SEC even issued a No Action letter in this matter, telling J&J that it would not object to the company’s exclusion of Professor Scott’s Proposal. (See our prior discussion of this action: https://pomlaw.com/ monitor-issues/can-shareholders-propose-bylaws-requiring-mandatory-arbitration-of-securities-fraud-claims). This has even been the rare issue about which investors and company management have tended to agree. In addition to J&J initially rejecting the mandatory arbitration proposal here, the board of directors of Intuit, another prominent public company, recently recommended against a similar proposal by Professor Scott, because it was “not in the best interest of Intuit or its shareholders.” Over 97.6% of Intuit’s shareholders agreed when they rejected the proposal. (See https://pomlaw.com/monitor-issues/intuit-shareholders-and-directors-reject-forced-arbitration-proposalintuit-shareholders-and-directors-reject-forced-arbitration-proposal).

Pomerantz has actively defended shareholders against forced arbitration beyond the courtroom as well. Several years ago, when the SEC hinted that it might consider allowing companies to include mandatory arbitration clauses in their bylaws, Pomerantz organized a coalition of large institutional investors from around the globe to meet with then-SEC Chairman Jay Clayton and later, with both Republican and Democratic Senate staffers. On November 13, 2018 – two weeks after the SEC meetings – ten Republican State Treasurers, in a letter co-authored by the State Financial Officers Foundation, urged the SEC to maintain their existing stance against forced arbitration. (See https://pomlaw.com/monitor-issues/protecting-share-holder-rights-forcing-away-forced-arbitration-clauses).

Shareholders must continue to be vigilant in protecting their right to bring securities class actions. Professor Scott is continuing to pursue his case against J&J, others seeking to impose mandatory arbitration on shareholders might continue to take up the matter in other forums, and the issue has not been addressed by the U.S. Supreme Court. Even so, the dismissal of Professor Scott’s earlier complaint against J&J is a great result for shareholders, especially given the overwhelming rejection by Intuit’s shareholders of Professor Scott’s mandatory arbitration proposal. J&J’s calling Professor Scott out on his true intention of pursuing his longstanding “academic interest” in seeking a favorable court ruling, rather than focusing on whether shareholders actually want his proposal, explains why there was no need for the Court to rule here on a purely hypothetical question.

Q&A: Dolgora Dorzhieva

POMERANTZ MONITOR | JULY AUGUST 2021

By The Editors

The Monitor recently spoke with Dolgora Dorzhieva, an associate in the firm’s securities litigation practice group.

Monitor: Could you tell us about your early years?

Dolgora Dorzhieva: I grew up in the city of Ulan-Ude, the capital of Buryatia, an ethnic republic in Eastern Siberia, Russia, near the border of Mongolia. Ulan-Ude is adjacent to Lake Baikal, the largest (by volume) and deepest lake in the world. I spent summers on my grandmother’s farm, in the remote village of Tashir. It had dirt roads, no internet, and often no electricity. At the age of 11, I herded sheep with German shepherd dogs, protecting the flock from wolves. I feel fortunate to have experienced what is now a disappearing lifestyle. My grandmother Vera taught school in the village. She and her sisters were orphaned during World War II. Vera managed to put herself and her two little sisters through school, starting when she was 11 and they were 5 and just under one year old. My Babula Vera was my academic inspiration and one of the smartest people I’ve ever met.

M: When did you decide to be a lawyer?

DD: I have wanted to be a lawyer since I was a little girl. In Russia, you cannot apply to law school by emailing documents remotely. You have to actually travel to each school, be interviewed, and take their exams. After graduating from high school with the gold medal (as class valedictorian), I convinced my mother to buy me a plane ticket to Moscow. I’d never been there, but somehow I got her to agree. All the law schools wanted money “under the table,” which I didn’t have, so I wasn’t accepted at any. I didn’t want to disappoint my family by coming back empty-handed. Having written articles for local newspapers, I opted for journalism.

M: Did you get a degree in journalism?

DD: No, following my fourth year (five being required for a degree), I came to New York as an exchange student on a J1 visa. Finding the freedom and opportunities in America irresistible, I stayed and eventually applied for political asylum. My four years of journalism have helped me as a lawyer. This job is as much about telling a story as journalism is.

M: What path led you to a career in securities fraud litigation?

DD: I took a “Complex Civil Litigation” class with Elizabeth Cabraser at Berkeley and she inspired me to pursue a career challenging the imbalance of power between average people, like you and me, and corporations.

M: What is the most intriguing issue that you have litigated so far?

DD: We have a case pending against Deutsche Bank, alleging that it violated its own Know Your Customer procedures when it onboarded and serviced Jeffrey Epstein. Unconscionably, Deutsche Bank knew that Epstein was using his accounts to further his crimes but failed to close them because he was so profitable for the bank.

M: What aspects of your work do you find most rewarding?

DD: As a plaintiffs’ securities litigator, it is rewarding to speak truth to power. I enjoy working with investigators and hearing the stories of confidential witnesses, which can be fascinating. The most rewarding aspect is the ability to solve someone’s problem and deliver a tangible result. I defeated a professional objector in a consumer fraud case and secured a favorable settlement in an individual employment case early in my career. I still have the text messages from the client in the employment case, who thanked me profusely. Those text messages remind me of why I became a lawyer. I also find it rewarding to pay it forward: I advise students from Berkeley on judicial clerkships.

M: A generation ago, women in law faced many challenges specific to their gender. As a member of a younger generation, how far do you think we have come, and how far do we still have to go?

DD: At Berkeley, I was fortunate to meet several women trailblazers who paved the way for my generation: Professor Eleanor Swift, Justice Maria P. Rivera of California’s Court of Appeal, Elizabeth Cabraser, and Professor Herma Hill Kay. In comparison with their struggles —and, thanks to them—young female lawyers now have a far easier path. We still have a long way to go, but I want to applaud my generation for being more assertive and open-minded about the role of women in law.

M: Have you faced special challenges in the United States as an Asian immigrant?

DD: Fortunately, I have not personally experienced direct racism here. In contrast, I was at university in Moscow during the war with Chechnya. There were skinhead gangs harassing and assaulting people like myself, on the streets and in the subway, who did not look Slavic like them. I had some frightening experiences. When I arrived in New York, it was a breath of fresh air. I love America and everything this country has bestowed on me. I came here alone, 21 years old, with limited English and a thousand dollars in my pocket. Hard work and perseverance helped me get this far; I don’t think that any other country in the world would allow an immigrant to do that. Two of my most exciting memories: the day I was accepted to Berkeley Law and the day I took the oath of allegiance as an American citizen.

M: What is your perspective on the American legal system?

DD: I think it’s one of the finest and certainly most sophisticated legal systems in the world. However, it has serious flaws, especially within the criminal justice system. Of course, the Russian legal system is notoriously corrupt. Not that the American legal system is perfect; however, many corrupt individuals do get caught and punished. The jury institution within the American legal system is the backbone of our democracy and our collective power as the People. American law is constantly evolving, allowing for a lifetime of learning.

M: What advice would you give to young women considering a career in law?

DD: The same advice I would give to young men: if you are not willing to work hard and make sacrifices in your personal life, this profession might not be for you. You should cultivate your organizational skills and attention to detail. To quote Hillary Clinton: “RTDD!” (Read the Damn Documents!) In other words, there are no shortcuts. Always remember: “You don’t know what you don’t know,” and that preparation is crucial.

M: What do you hope to achieve over the next decades?

DD: I want to learn the ins and outs of trials and become an excellent trial attorney. One day, I hope to look back on an exciting career in which I have helped others.

M: Outside of the office, what are your interests or hobbies?

DD: I love nature and spend what time I can hiking in New Jersey or relaxing on the beach, at Sandy Hook. I haven’t gone to the movies since the pandemic; I miss that. A professor at City College of New York showed us “12 Angry Men;” that led me to Turner Classic Movies. I only recently saw “The Wizard of Oz;” I loved it! Music has been a huge passion since I was a kid, from the Beatles to Billie Eilish, and I really enjoy the great American art form: jazz. Miles Davis’s “Sketches of Spain” was instrumental in me passing the bar.

85 Years – The Case That Quashed Fee-Shifting Bylaws

POMERANTZ MONITOR | JULY AUGUST 2021

By The Editors

In celebration of the founding of the Pomerantz Firm 85 years ago, the Monitor continues its look back at highlights from its history.

On May 30, 2014, First Aviation Services, Inc. completed what was virtually a hostile takeover, executing a 10,000-to-1 reverse stock split that effectively took the company private by involuntarily cashing out every investor holding less than 10,000 shares. When the dust settled, Aaron Hollander, First Aviation’s Chief Executive Officer and controlling shareholder, had effectively taken ownership of the company without needing to lay out any capital. Adding insult to injury, within four days of the stock split coup, First Aviation adopted a fee-shifting bylaw that required any stockholder who challenged the ouster of their investment to pay the company’s legal fees unless they succeeded in obtaining “a judgment on the merits that substantially achieves ... the full remedy sought.” Unless any challenger prevailed on every issue that they argued, they would be forced to pay the uncapped legal fees incurred by the company.

Setting the stage for a showdown, the Delaware Supreme Court took on the issue of fee-shifting bylaws in a 2014 case named ATP Tour, Inc. v. Deutscher Tennis Bund. ATP, the operator of a professional men’s tennis tour, had successfully defeated litigation by two member federations that arose from changes made to the format and scheduling of the tour, and sought to recover its legal fees per its fee-shifting bylaw. The Delaware Supreme Court ruled that “[u]nder Delaware law, a fee-shifting bylaw is not invalid per se, and the fact that it was adopted after entities became members will not affect its enforceability.”

The same year, Pomerantz was approached by a client seeking to stop the forced liquidation of his investment in First Aviation. With a genuine interest in the company and its financial prospects, the investor had no interest in being forced to divest his shares, especially at a rate that was several dollars below what the stock had recently traded at. Although the classwide damages were modest, Pomerantz considered the issue important, and took on the case on behalf of this client and approximately 200 other investors who were just two weeks away from being booted as shareholders.

After the complaint against First Aviation (Strougo v. Hollander) was filed, a series of ‘after the fact’ revelations raised the stakes of the case on several levels. First, the company revealed that it had received a large government contract — one that it knew about before the reverse stock split was announced but failed to disclose to the market — and one from which the now cashed-out investors would not realize any benefit. Second, First Aviation revealed the existence of the fee-shifting bylaw that placed the plaintiffs in substantial potential financial jeopardy. And, later in the litigation, as we will recount, a third revelation provided the key to victory.

While Pomerantz was uncovering the true depth of the deception surrounding the reverse stock split, the plaintiffs’ bar at large took notice of this modest securities case. The potential recovery was just a few hundred thousand dollars, but an adverse ruling that saw such bylaws being sustained threatened the future viability of securities litigation as we know it. The adoption of fee-shifting bylaws would be the death knell for shareholder litigation, as no plaintiff would risk being on the hook for legal fees and expenses.

With those stakes in the balance, the attention on this case was intense. Pomerantz partners Gustavo Bruckner, Marc Gross and Jeremy Lieberman were deluged with missives from other plaintiffs’ firms attempting to persuade them to either not litigate Hollander, or to allow larger firms to step in to find some solution ... any solution ... other than a judicial decision.

Under tremendous pressure not to risk an adverse ruling, Pomerantz saw an opening — ask the court to stay its ruling on the complaint itself but split out the issue of the bylaw first for a ruling on its validity. Recognizing the larger issue at hand, the Court agreed.

It was at this stage that Pomerantz made a shocking discovery — the yet-to-be seen bylaw had been adopted a mere four days after the stock split and applied retroactively to all shareholders, even those who were cashed out in the transaction.

This revelation drew the map for a pathway to victory without jeopardizing the foundation of securities litigation. Pomerantz asked the Court to further limit its ruling to one question — is a bylaw adopted after a former stockholder has already cashed out still binding on them? Clearly, bylaws are binding on all current shareholders at the time of adoption and those who buy stock afterwards. But, based on the principle of Delaware law that has positioned the stockholder-corporation relationship as akin to a contract, that ‘contract’ would end as soon as the stock is either sold or taken away — as in the situation of a cashed-out reverse stock split. It followed that a fee-shifting bylaw, adopted after the investor is no longer holding stock in the company, would not apply to them.

As a result, in March 2015, Chancellor Bouchard of the Delaware Court of Chancery ruled that “[A] stockholder whose equity interest in the corporation is eliminated in a cash-out transaction is, after the effective time of that transaction, no longer a party to [the] flexible [corporate] contract. Instead, a stockholder whose equity is eliminated is equivalent to a non-party to the corporate contract, meaning that former stockholder is not subject to, or bound by, any bylaw amendments adopted after one’s interest in the corporation has been eliminated.”

On the effect of fee-shifting bylaws, the Chancellor further wrote that “the Bylaw in this case would have the effect of immunizing the Reverse Stock Split from judicial review because, in my view, no rational stockholder— and no rational plaintiff’s lawyer—would risk having to pay the Defendants’ uncapped attorneys’ fees to vindicate the rights of the Company’s minority stockholders, even though the Reverse Stock Split appears to be precisely the type of transaction that should be subject to Delaware’s most exacting standard of review to protect against fiduciary misconduct.”

Simultaneously, as Pomerantz sought to sway the court, it also spearheaded efforts to find a legislative solution that would forestall any fallout in the event of an adverse decision in Hollander. The Firm campaigned to educate Delaware’s governor, Supreme Court, and legislature in regard to the scope of the threat that fee-shifting bylaws posed to shareholder rights and the balance of the corporate ecosystem — an issue very germane in the state that is the home of the most newly formed corporations every year.

After discussions between prominent legal academics, members of Delaware’s executive, judicial, and legislative branches, and the representatives of the plaintiffs’ bar, examining the effect that fee-shifting bylaws would likely have on shareholders’ rights and their ability to mount legal challenges to corporations in court, Delaware realized it needed to act. On June 11, 2015, the Delaware General Assembly passed Senate Bill 75, a statute which amended the Delaware General Corporation Law to effectively prohibit fee-shifting bylaws. Governor Jack Martell signed the bill into law on June 25, 2015.