Pomerantz, the oldest securities law firm in the United States, proudly celebrates its 80th birthday

Pomerantz was founded in 1936 by Abraham L. Pomerantz, who, during his legendary career, relentlessly fought to protect investor rights. In doing so, he secured numerous victories now enshrined in the laws applied to securities class actions and derivative lawsuits.

Abe’s trailblazing spirit lives on at Pomerantz – from our historic Supreme Court victory recognizing the right to a jury trial in derivative actions in 1970, to being appointed sole lead counsel in 2015 in the action against Brazilian oil giant, Petróleo Brasileiro SA – Petrobras, surrounding its conduct in one of the largest corruption and bribery scandals of the 21st century. Although our client did not suffer the largest financial loss, the court found that Pomerantz’s outstanding reputation and the client’s conduct in overseeing counsel represented the “gold standard” for institutional investors seeking to move for appointment as lead plaintiff.

We are celebrating our 80 years with a bang. Pomerantz acts as lead counsel in a closely-watched securities class action lawsuit against ChinaCast Education Corp., stemming from its CEO’s alleged misappropriation of $120 million in company funds. The Ninth Circuit recently revived the case – after its dismissal by a lower court – ruling that the CEO’s fraud could be imputed to ChinaCast, even though his alleged embezzlement and misleading of investors went against the company’s interests. The litigation will now return to the lower court for trial.

Pomerantz is co-lead counsel in a securities class action against S.A.C. Capital Advisors LLC, in which the court recently certified two classes of plaintiffs. The case arises from the most profitable insider-trading scheme ever uncovered, in which the defendants illegally gained profits and avoided losses of at least $555 million from trades in Elan Corporation plc and Wyeth Pharmaceuticals, Inc. securities and related options while in possession of material, non-public information.

In 2015, Pomerantz defeated defendants’ motion to dismiss the class action against Barclays plc for misstatements about its “dark pool.” The court found that, although revenues from Barclays’ dark pool were under 5% of company revenues – a statistical benchmark often used to assess materiality – the misrepresentations went to the heart of its reputation and were therefore actionable. The decision is a victory for investors for its recognition that corporate integrity and ethics are material factors upon which investors rely when purchasing securities, even where the mounts of money involved fall below a presumptive numerical threshold.

Pomerantz acts as lead counsel for investors in a securities class action against Groupon for alleged misconduct related to its 2011 initial public offering, a case in which we have won every substantive motion to date. One of the most important milestones was our defeat of a defense motion to disqualify the plaintiffs’ class certification expert in March 2015. The defense argued that he was unreliable as he failed to conduct put-call parity and short lending fee analyses. We disagreed, citing the landmark U.S. Supreme Court ruling in Halliburton. After an extensive evidentiary hearing, the court sided with Pomerantz, holding that such tests were unnecessary because they addressed an extreme variation of market efficiency that “was squarely rejected by the Halliburton court.”

We are lead counsel in a securities class action against Walter Investment Management Corporation, in which the court dismissed our original complaint, while granting leave to file an amended complaint. Pomerantz then prevailed, overcoming the difficult burden to prove, in the motion to dismiss phase, that disclosure of a government investigation of and proposed enforcement action against the company satisfied the requirement for loss causation. Given the Myers/Loos standard prevailing in the Ninth and Tenth Circuits, which strictly limits the circumstances under which the announcement of a government investigation can be said to cause a loss, this victory is significant.

Auditing the Auditors

ATTORNEY: JOSHUA B. SILVERMAN
POMERANTZ MONITOR JANUARY/FEBRUARY 2016

Investors rely on auditors to insure the integrity of corporate financial statements, but have little insight into the individual auditors themselves. That is about to change. A new rule adopted by the Public Company Accounting Oversight Board (PCAOB) will soon provide investors with much more transparency into the audit partners conducting the audit, and whether the audit firm outsourced substantial audit work.

Currently, auditors hide behind a mask of anonymity. They sign the opinion letters that go into SEC filings under the firm name only. But as recent PCAOB inspection reports confirm, even “big four” auditors produce shoddy audits with alarmingly high frequency. In its most recent inspection, the PCAOB found that KPMG was deficient in 54% of inspected audits. The remaining “big four” were only modestly better: EY 36%, PwC 29%, Deloitte 21%.

According to PCAOB chair James Doty, many of those bad audits were produced by particular engagement partners. In a recent statement, he explained that “PCAOB inspections have revealed that, even within a single firm, and notwithstanding firm-wide or network-wide quality control systems, the quality of individual audit engagements varies. There are numerous factors required to achieve a high quality audit, but the role of the engagement partner in promoting quality, or allowing it to be compromised, is of singular importance to the ultimate reliability of the audit.”

SEC enforcement actions confirm that some engagement partners are repeat offenders. For example, a recent action against Grant Thornton shows that the same partner, Melissa Koeppel, overlooked at least three major accounting frauds in public companies: headphone-manufacturer Koss, Assisted Living Concepts (ALC), and Broadwind. In its 2008 inspection of Grant Thornton, the SEC highlighted deficiencies in one of Ms. Koeppel’s audits. By the third quarter of 2010, Ms. Koeppel’s public company audit clients had restated financials four times, and Ms. Koeppel was on an internal monitoring list at Grant Thornton for partners with negative quality indicators. Her track record was so bad that Grant Thornton switched most of her audits to other engagement partners, but it kept her on the 2010 audit of ALC. Those financial statements had to be restated due to accounting irregularities that were brought to Ms. Koeppel’s attention by subordinates, but were ignored.

Investors will soon get a new tool to help identify bad auditors like Ms. Koeppel. A recently-adopted PCAOB rule will require audit firms to file forms indicating the name of the engagement partner. The rule also requires identification of other firms that assisted in the audit, and the extent of their participation.

While the rule is an improvement, it was watered down under heavy pressure from accounting industry lobbyists. The original proposal called for the engagement partner to be identified directly in SEC filings, either in the audit opinion itself or by the issuer. The current rule places the information in a separate form, so investors will have to look in multiple places to find information about the audit. But this additional hurdle is minor. Over time, it may not pose any problem at all, as financial information providers like Bloomberg and Reuters begin to link audit engagement partner  track record information into their profiles of corporate issuers.

Your Right to Know If Your Personal Information Has Been Hacked

ATTORNEY: PERRY GATTEGNO
POMERANTZ MONITOR JANUARY/FEBRUARY 2016

In today’s digitized world, every day, nearly every consumer willingly or unwittingly shares sensitive personal information online. Almost as often, hackers successfully access corporate information databases, taking whatever data they can find.

Fortunately, nearly every state has data breach notification laws that apply to any entity that collects personally identifiable information. Those laws generally require the collecting entity to notify individuals when their personal information has been accessed by an unauthorized user. The first such law, enacted in California in 2003, set the model for data breach notification mechanisms by creating obligations for “any agency that owns or licenses computerized data that includes personal information.” In the case of a breach of security systems, the hacked company must disclose the breach to any California resident whose unencrypted personal information was, or is reasonably believed to have been, acquired by an unauthorized person.

The definition of personal information varies from state to state, but it generally includes names, telephone and Social Security numbers, home and e-mail addresses, and any information that falls under the umbrella of “personally identifiable information.” As defined by the California law, this extra information includes credit and financial data that creates access to private accounts, and driver’s license numbers. In California, only unencrypted information that has been transmitted to unauthorized persons must be reported, so California entities can obviate their reporting duties by encrypting all data.

Generally, the statutes include language requiring disclosure of the breach “without unreasonable delay,” (Connecticut, among others), “in the most expedient time possible” (Delaware, among many others) or “as soon as possible” (Indiana, among others). Most states allow the hacked company to wait until “delay is no longer necessary to restore the integrity of the computer system or to discover the scope of the breach,” or also to comply with a criminal or civil investigation by law enforcement. Some states, such as Louisiana, allow the breached entity not to notify consumers of a breach “if after a reasonable investigation the person or business determines that there is no reasonable likelihood of harm to customers.”

In the 13 years since the California law took effect, 47 states, as well as the District of Columbia, Guam, the U.S Virgin Islands and Puerto Rico, have enacted some form of data breach notification law. While they all authorize the local attorney general to enjoin violations and create civil and sometimes criminal penalties against violators, fewer than half the states also grant a private right of action to individuals whose data has been stolen. Civil penalties collectible by the state generally range from $100 to $2,500 per violation, while private rights of action generally permit aggrieved parties to recover actual damages, and often reasonable attorneys’ fees, from the hacked entity. These rights create a strong incentive to disclose these breaches to victims of a data breach. Illinois and California are among the states where a private right of action exists, while New York and Florida are among the states where there is no private right of action.

Nevertheless, holders of confidential data must also weigh the public relations nightmare that often accompanies data breaches, which are becoming high profile – and thus high-stakes – messes requiring immediate clean-up. Failing to comply with the relevant statute not only creates liability, it also causes embarrassment and discourages individuals from entrusting their data to the guilty party.

 Even those states that do not have a private right of action may have unfair trade practices statutes that may provide an alternative route to recovery. For instance, the Florida Deceptive and Unfair Trade Practices Act (FDUTPA) allows recovery of damages and attorneys’ fees for “unfair methods of competition, unconscionable acts or practices, and   unfair or deceptive acts or practices in the conduct of any trade or commerce.” Because FIPA, Florida’s data breach notification statute, defines a violation as an unfair or deceptive trade practice, the state statutory scheme essentially creates a single private right of action rather than FIPA creating a second one on top of the existing statute. FIPA merely creates a new category that falls under FDUTPA’s umbrella. The interplay around the country between analogous statutes varies by state.

Permitted methods of notification vary by state, but generally written notice, e-mail notice, or telephone/ fax notice are options if the breached entity has such consumer information in its possession. Some states permit alternatives in the vent that none of the previous methods are available, such as “Conspicuous posting of the notice on the Internet Web site page of the [breached] person or business, if the person or business maintains one” and “notification to major statewide media.”

Data breach notification laws confirm and crystallize the duties and obligations of entities that undertake to collect personally identifiable information of individuals. Even the best-intentioned holders of data may occasionally suffer unintentional breaches of information, but these laws incentivize stringent security and prompt action to mitigate harm wherever and whenever it might occur.

Court Upholds our Claims Against Lumber Liquidators

ATTORNEY: MICHAEL J. WERNKE
POMERANTZ MONITOR JANUARY/FEBRUARY 2016

Judge Allen of the Eastern District of Virginia recently denied defendants’ motion to dismiss our class action complaint against Lumber Liquidators Holdings, Inc. During the class period, the company, which sells hardwood and laminate flooring, reported record gross margins that were substantially higher than its major competitors’. Defendants represented that the major driver of these high margins was legitimate “sourcing initiatives” in China that supposedly reduced the cost of goods and cut out middlemen. In truth, however, the company’s high margins were due to importing cheap flooring made from illegally harvested wood and laminate that was contaminated with high levels of formaldehyde. When the truth emerged in a series of disclosures and events – including news of federal criminal charges for violations of the Lacey Act and the well-substantiated, televised broadcast by 60 Minutes of extensive wrongdoing -- the stock price plunged by 68%. In the aftermath, the board suspended the sale of Chinese laminate products, the CEO, CFO and the company’s “Head of Sourcing” abruptly resigned, and the company replaced its compliance officer.

The court held that the complaint adequately alleged that defendants’ statements were false: its increased margins were not due to legitimate “sourcing initiatives,” or to the company’s efforts to work with mills to produce flooring that meets their “high quality standard,” or to policies to ensure regulatory compliance, as the company had said. In fact, the company later admitted that its Chinese suppliers failed to adhere to regulations and that it did not build a compliance team in China until December 2014.

The court also held that the complaint raised a strong inference of scienter, because defendants had access to non-public information suggesting that their statements were false; third parties easily discovered the regulatory violations; defendants repeatedly discussed analyst calls regarding their personal involvement in the sourcing initiatives in China that were driving their margins higher; and defendants sold a majority of their stock during the class period. The court found that, given the importance and focus of the sourcing initiatives in China, it was part of the “core operations” of the business, another factor that supported the conclusion that management must have known the truth. Finally, the court imputed to management, and to the company, the knowledge of its head of sourcing.

Finally, the court found that the complaint adequately pleaded loss causation because the partial disclosures, when “taken together.... revealed the widespread scope of defendants’ allegedly fraudulent scheme.”

How Bad Does the Behavior Have to Be Before Shareholders Can Investigate It?

ATTORNEY: ANNA KARIN F. MANALAYSAY
POMERANTZ MONITOR JANUARY/FEBRUARY 2016

As the Monitor has previously reported, shareholders of Delaware corporations have a right to demand access to books and records of their company, provided that they have a “proper purpose” for doing so. One proper purpose is to investigate whether corporate officers and directors have violated their fiduciary duties. But merely expressing a desire to investigate such a possibility is not enough; the shareholder has to show that there are reasonable grounds to suspect that such a breach may have occurred. Many cases have explored the question of how much smoke there has to be to create a reasonable suspicion that there may well be a fire worth investigating.

Recently corporations have ratcheted up the argument. Now, they say, not only must there be grounds for suspicion of a breach, but that breach must be of the type that is compensable in damages. Since a books and records complaint is filed before there is any claim on file for breach of fiduciary duty, this argument requires that the court forecast the type of claim that might be made in the future.

Delaware law provides broad protections for directors against damage claims based merely on violations of the duty of care; only much more serious violations, such as breaches of the duty of loyalty, are compensable in damages. To escalate a claim of carelessness into a duty of loyalty claim, the shareholder must be able to show extreme misconduct -- the type of conduct that is hard to plead without company records to provide the crucial details. Those, of course, are the very details that the inspection provisions of Delaware law were intended to provide. It is to obtain such information that the shareholders bring a books and records proceeding in the first place. This question is now being considered by the Delaware Supreme Court in a case involving the AbbVie corporation, in which oral argument was heard on November 4, 2015.

In the action, Southeastern Pennsylvania Transportation Authority (“SEPTA”), a shareholder of AbbVie, sought access to AbbVie’s books and records relating to AbbVie’s failed $55 billion merger with Shire. Plaintiff claimed that it had a proper purpose because it wanted to investigate whether the AbbVie directors breached their fiduciary duties in connection with the approval of that merger.

The goal of the merger was to allow AbbVie to take advantage of Jersey’s more favorable tax laws, since Shire is incorporated in Jersey, a tiny island principality off the coast of Normandy that is controlled by England. If the merger had been consummated, AbbVie’s tax rate for 2016 would have dropped from about 22 percent to roughly 13 percent. About two months after the announcement of the merger, the Treasury Department and Internal Revenue

Service, alarmed over the possible drop in tax revenues from such “inversion” transactions, vowed to take action to deter American companies from acquiring foreign competitors to avoid domestic taxes. The AbbVie board responded by withdrawing its recommendation that stockholders vote in favor of the deal. The AbbVie board ultimately terminated the deal and paid Shire a $1.6 billion contractual termination fee.

SEPTA argued that it had a right to investigate the question of whether AbbVie would not have had to pay $1.6 billion if the AbbVie board had properly evaluated the risks of the merger, as required by their fiduciary duty. SEPTA demanded that AbbVie produce board minutes, correspondence, and other documents to investigate potential corporate wrongdoing.

In denying the books and record demand, Vice Chancellor Glasscock inferred that they were seeking an investigation to aid in future derivative litigation against the directors.

The court then held that if a plaintiff’s sole purpose for seeking inspection was to decide whether to bring derivative litigation to recover for alleged corporate wrong- doing, a proper purpose exists only if the plaintiff has demonstrated that the possible wrongdoing would be compensable in damages, and was not barred by the “raincoat” protections of Delaware law. Because SEPTA did not show that the conduct it was investigating could possibly rise to the level of a duty of loyalty claim, the court dismissed the inspection demand.

On appeal, SEPTA argued that the lower court’s decision essentially puts stockholders in the impossible situation of having to show exactly how serious the potential breaches of fiduciary duty might be before they could gain access to the records they would need to make that decision. AbbVie countered that without such detailed information, SEPTA was engaged in a mere fishing expedition, which the books and records statute does not allow.

Even if the appeal is denied, however, the Vice Chancellor, on several occasions, specifically noted that SEPTA sought inspection solely to investigate whether to bring derivative litigation, and that in order to state a proper purpose the claims must be non-exculpated. An exculpatory provision, however, does not bar all derivative litigation, and, accordingly, even in the face of an exculpatory provision, under certain circumstances investigating potential derivative litigation may still be a proper purpose. For example, claims seeking injunctive relief, such as an order barring consummation of a merger, or requiring additional disclosures, are not exculpated and therefore could be explored in a document inspection. At the early stage where a books and records case is filed, the plaintiff shareholder has not yet made any specific claims of actual wrongdoing, and can posit that, depending on what the documents may show, all sorts of non-exculpated relief could be possible.

Where's The Accountability?

ATTORNEY: TAMAR A. WEINRIB
POMERANTZ MONITOR NOVEMBER/DECEMBER 2015

At a conference last year, SEC Chair Mary Jo White began by asserting that “strong enforcement of our securities laws is critical to protecting investors and maintaining their confidence and to safeguarding the stability of our markets.” She went on to suggest that one of the SEC’s primary roles is to “bring wrongdoers to account and to send the strongest possible message of deterrence to would-be fraudsters.”

However, often the message sent is hardly one of deterrence. Many an SEC settlement amounts to nothing more than a mere “cost of business” for the wrongdoer, which is ultimately borne by the shareholders, particularly where the settlement terms do not require any accountability. Indeed, it was for precisely this reason that Judge Rakoff initially rejected the SEC’s $285 million settlement with Citigroup in 2011 that stemmed from the bank’s sale of mortgage-backed securities that cost investors $700 million but yielded a $160 million profit for the bank. Judge Rakoff referred to the settlement, which required no admission of wrongdoing, as “pocket change.”

Although the SEC has obtained admissions of wrongdoing in some cases, the Citigroup settlement was not unique in its failure to require Citigroup to either admit or deny liability (indeed Judge Rakoff rejected a settlement between the SEC and Bank of America in 2009 for similar reasons) but it prompted Judge Rakoff to proclaim that it “is neither fair, nor reasonable, nor adequate, nor in the public interest.” Just last month, the SEC entered into yet another settlement with two units of Citigroup that holds no one at the bank accountable for selling municipal bonds to wealthy clients for six years as a safe money option despite the innate risk resulting from considerable leverage, which caused investors to lose an estimated $2 billion. This settlement, for $180 million, like the settlement in 2011, did not require Citigroup to either admit or deny wrongdoing. Once again, it is the innocent investors who will bear the settlement cost.

The SEC is not alone in its zeal to settle claims with no accountability. The New York State Attorney General announced a settlement with Bank of America and former CEO Ken Lewis in 2014 over statements made in connection with the 2008 BofA and Merrill Lynch merger. Specifically, the SEC accused BofA of failing to reveal the truth about $9 billion in losses at Merrill Lynch before voting to approve the merger. After the merger, BofA needed a federal bailout partly because of the increasing losses at Merrill Lynch, and investors suffered when shares took a nosedive. The $25 million settlement did not require any admission of wrongdoing by either BofA or Lewis. Moreover,

BofA ultimately paid the $10 million of the settlement amount that Lewis was supposed to pay. In other words,

Lewis walked away from the settlement unscathed and therefore undeterred. Settlements such as these are ineffectual at deterring future misconduct by either the settling party or other entities and executives.

The question, however, is what the consequences are of the alternative. There exists a particularly sharp double-edged sword when considering the nature of the “deterrent.” The obvious concern is that if regulators continue to enter settlements that require no admissions of wrongdoing, those settlements will unlikely deter future misconduct but rather create a cost of business that further victimizes, rather than protects, investors. However, on the flip side, if regulators were to require admissions of wrongdoing as a condition to any settlement, the risk is that far fewer such actions/investigations would result in a settlement. Companies hesitant to admit any wrongdoing lest an investor or other party use that admission against it in a private lawsuit will not as readily agree to settle, which will undoubtedly result in protracted and costly litigation with uncertain outcomes. The question is what is the true goal --- to deter future misconduct as regulators consistently proclaim or to settle as many actions as possible, thereby avoiding the costs of lengthy litigation and the withering of budgetary constraints?

 Perhaps the greatest deterrent to securities fraud would be criminal prosecutions of individual wrongdoers, which is the prerogative of the Justice Department. The track record there has, if anything, been even spottier. The recent spate of insider trading convictions has been drastically undermined by the Second Circuit’s landmark ruling in the Newman case, which raises the bar dramatically for insider trading convictions. Other types of securities fraud criminal convictions of individuals are almost completely nonexistent.

Shareholder Approval Of Merger Held To Eliminate Claims Against Conflicted Investment Bankers

ATTORNEY: MATTHEW C. MOEHLMAN
POMERANTZ MONITOR NOVEMBER/DECEMBER 2015

On October 29, 2015, Vice Chancellor Parsons of the Delaware Court of Chancery dismissed the sole remaining claim in In re Zale Corporation Stockholder Litigation, the shareholder suit arising from Zale’s 2014 merger with Signet Jewelers Ltd. The Zale opinion, in which Parsons reversed his own earlier ruling in light of binding new precedent from the Delaware Supreme Court, serves as a blunt reminder to investors that Delaware courts are highly reluctant to meddle with the decisions of corporate boards.

In the suit, the Zale plaintiffs had alleged that they were cashed out of their investment at an unreasonably low price due to the involvement of a conflicted financial advisor, Bank of America Merrill Lynch. Zale’s Board of Directors retained Merrill Lynch to advise it as to the financial fairness of the merger. In accepting the engagement, Merrill Lynch failed to inform the Board that it had recently met with Signet to pitch an acquisition of Zale. Notably, the same Merrill Lynch investment banker who led the team advising Zale’s Board had also led the team that pitched to Signet. Further, in the pitch meeting, Merrill Lynch had suggested that Zale pay no more than $21 per share for Zale, and ultimately, the merger was approved by Zale’s Board for an acquisition price of $21 per share. Finally, while Merrill Lynch ultimately informed the Board of its meeting with Signet, it waited to do so until after the merger was announced.

On those allegations, the plaintiffs asserted a claim for breach of fiduciary duty against the Board for insufficiently vetting Merrill Lynch for potential conflicts of interest, and against Merrill Lynch for aiding and abetting the Board’s breach by concealing the conflict from it. Plaintiffs sued Merrill Lynch as aiders and abettors because the bankers owed no fiduciary duties to shareholders.

Initially, Vice Chancellor Parsons found that the plaintiffs had plausibly alleged that Zale’s Board had breached its duty of care to shareholders by not ferreting out Merrill Lynch’s conflict. Parsons noted that Zale had “rather quickly decided to use Merrill Lynch, the only candidate they considered,” and did not ask probing questions designed to detect conflicts of interest, such as whether the bank had made any presentations regarding Zale to prospective buyers within the last six months. Nevertheless, Parsons dismissed the Board from the suit due to an exculpatory charter provision—a protection permitted by Delaware statute that insulates directors from damage claims based on breach of their duty of care. But Parsons sustained the aiding and abetting claim against Merrill Lynch for failing to promptly disclose its meeting with Signet to the Board, which potentially allowed Signet to have the upper hand in negotiations.

However, the day after Parsons issued his opinion, the Delaware Supreme Court undercut it. Specifically, in Corwin v. KKR Financial Holdings LLC, the high court held that a fully-informed vote by an uncoerced majority of disinterested stockholders invoked the deferential “business judgment” standard of review. Practically speaking, business judgment review precludes second guessing of Board decisions, and its application is typically outcome-determinative against shareholder plaintiffs.

The Zales-Signet merger had been approved by 53% of Zale’s shareholders. Accordingly, under Corwin, Parsons should have evaluated the Board’s conduct in vetting Merrill Lynch under the business judgment standard. Parsons had instead applied the stricter “enhanced scrutiny” standard of review. Parsons held that enhanced scrutiny was appropriate under the Delaware Supreme Court’s 2009 decision in Gantler v. Stephens, which he found did not mandate business judgment review where a shareholder vote was statutorily required. Corwin clarified that Parsons had misread Gantler. Corwin said where the approving shareholders were disinterested, fully-informed and uncoerced, it did not matter whether their vote was required or purely voluntary—business judgment was the standard of review. Corwin thus made it exceptionally difficult to find that Zale’s Board had breached its duty of care to shareholders. And because Merrill Lynch’s liability as an aider and abettor was predicated on the Board’s duty breach, the Corwin holding benefitted it as well.

So, after politely holding off for three days —no doubt to give the Zale plaintiffs time to wind up their affairs and come to terms with the inevitable—Merrill Lynch moved for reargument in light of the holding in Corwin. Parsons saved Merrill Lynch the trouble, reconsidering his earlier ruling and dismissing the bank from the case. Perhaps showing his ambivalence at the result, he observed that, “The conduct of Merrill Lynch in this case is troubling, and it was disclosed only belatedly to the Zale Board.”

In a broad sense, the Zale opinions, and the holding in Corwin, illustrate the substantial protections that Delaware continues to afford the directors of companies incorporated there—estimated to be 50% of all U.S. public corporations. By clarifying that banker conflicts may be scrutinized less after a merger receives shareholder approval, it also marks an important qualification to the series of scathing banker conflict opinions that have boiled out of the Court of Chancery in recent years.

For example, in In re Del Monte Foods Co. Shareholders Litigation, Vice Chancellor J. Travis Laster found that Del Monte’s financial advisor Barclays PLC had “secretly and selfishly manipulated the sales process to engineer a transaction that would permit Barclays to obtain lucrative buy-side financing fees.” Likewise, in In re El Paso Corporation Shareholder Litigation, former Chancellor, now Chief Justice of the Delaware Supreme Court, Leo Strine skewered El Paso Board advisor Goldman Sachs for “troubling” conduct that led him to conclude that the transaction was “tainted by disloyalty.” And in In re Rural/Metro Corporation Stockholders Litigation, Vice Chancellor Laster took aim at RBC Capital for steering Rural/Metro’s Board to consummate a deal with an acquirer that RBC secretly hoped would hire it to provide financing for the transaction.

Such rulings are salutary because they recognize that bankers wield considerable influence in merger transactions, and that a self-interested sell-side banker can prevent shareholders from realizing maximum value when cashed out of their investments. As the outcome in Zale shows, Corwin makes it that much more difficult to show director liability after a merger has been consummated. The further rub for investors is that, after Corwin, bankers enjoy more flexibility to act selfishly and against shareholders’ interests —so long as they make the perfunctory disclosures, the deal gets done, and the merger is approved.

Petrobras Court: Opt-Outs Beware

ATTORNEY: MARK B. GOLDSTEIN
POMERANTZ MONITOR NOVEMBER/DECEMBER 2015
 

As reported in previous issues of the Monitor, Pomerantz is lead counsel in a class action lawsuit against the Brazilian oil giant Petrobras. Lead Plaintiff Universities Superannuation Scheme Limited and additional institutional plaintiffs allege securities fraud violations that stem from a large-scale undisclosed bribery and money-laundering scheme that caused tens of billions of dollars of damages to shareholders. On July 9, 2015, the court denied most of defendants’ motions to dismiss, upholding, most notably all of our Securities and Exchange Act claims. The class includes investors who purchased their Petrobras shares after January 22, 2010.

Some investors had decided to opt out of our class action, and to file individual suits. Defendants moved to dismiss their claims as well; and on October 19, 2015, Judge Jed S. Rakoff of the Southern District of New York dismissed their claims “to the extent such claims under Section 10(b) of the Exchange Act cover purchases prior to June 2, 2010, on the ground that such claims are barred by the statute of repose.”

In our class action, by contrast, the court upheld claims going back six months earlier, to January 22, 2010. Therefore, by opting out, these individual plaintiffs forfeited six months’ worth of claims.

 The statute of repose for the Exchange Act bars claims brought more than five years after the occurrence of the fraud. The fraud is deemed to have occurred on either the date the investor purchased the stock or the date of the act or transaction constituting the violation.

 Unlike a statute of limitations, the statute of repose is not concerned with when the investor discovers that he or she has a claim for securities fraud. It acts as a bar to all claims under the securities laws and begins to run from the date the investor purchased the security or from the date of the act or transaction constituting the violation. This five year period had not yet run on any of our claims when we brought our class action.

In opposing the motion to dismiss, the opt-out plaintiffs argued that the statute of repose should be tolled (stopped) for the period these plaintiffs were part of the class. In a case called American Pipe the Supreme Court held that such tolling applied to the statute of limitations: “the commencement of a class action suspends the applicable statute of limitations as to all asserted members of the class.” There currently exists a split among the circuits regarding whether the American Pipe doctrine applies to plaintiffs who elect to opt out of a pending class action prior to a decision on class certification, and a number of district courts, the Sixth Circuit, and the First Circuit have held that tolling of the statute of limitations is not available in such circumstance.

 However, in a case called IndyMac, the Second Circuit held two years ago that the statute of repose under the Exchange Act is not covered by American Pipe tolling. In particular, the Second Circuit ruled, “in contrast to statutes of limitations, statutes of repose create a substantive right in those protected to be free from liability after a legislatively- determined period of time.” The reasoning is that the statute of repose allows issuers and underwriters of securities to know, by a date certain, when all potential claims arising out of a particular securities issuance have been extinguished. This holding was followed by Judge Rakoff when he dismissed the opt-out plaintiffs’ claims covering Petrobras purchases prior to June 2, 2010.

While there may sometimes be good reasons for institutions with large claims to opt out of a class and bring their own actions, they do so at the risk that they will lose some of their claims because of the statute of repose.

Pomerantz Beats The “Adverse Interest” Exception Again

ATTORNEYS: MARC C. GORRIE AND EMMA GILMORE
POMERANTZ MONITOR NOVEMBER/DECEMBER 2015

A few months ago the Monitor reported that Pomerantz had defeated a motion to dismiss our Petrobras action, persuading the District Court to reject a defense based on the so-called “adverse interest” rule. There we persuaded the court that the company, Petrobras, a Brazilian company, could be responsible for frauds committed by its senior executives. Contrary to the company’s arguments, the court concluded that Petrobras derived some benefits from the frauds and its interests were therefore not entirely adverse to those of the individual wrongdoers.

Now we have prevailed over that defense again, this time in a case involving a Chinese company, ChinaCast. In a resounding victory for the firm and the class of investors we represent, the United States Court of Appeals for the Ninth Circuit, in a question of first impression, unanimously held that a senior corporate employee’s fraud is imputed to the corporation even when the fraud actually is completely adverse to the company’s interests. ChinaCast is a for-profit, post-secondary education and e-learning service provider that gives courses online and on three physical campuses in China. Founded in 1999, its shares traded on the NASDAQ Global Select Market, at one time boasting a market capitalization of over $200 million. In March of 2011 ChinaCast filed a Form 10-K with the Securities and Exchange Commission in which it disclosed that its out-side accounting firm, Deloitte Tohmatsu CPA, Ltd., had identified “serious control weaknesses” in its financial oversight systems.

Both sides in our case essentially agreed on the underlying facts. A massive fraud occurred at ChinaCast when its CEO and founder, Ron Chan Tze Ngon, looted the company and brought it to financial ruin. Chan improperly transferred $120 million of corporate assets to bank accounts that he and his associates controlled, allowed a vice president to transfer $5.6 million in Company funds to his son, transferred control of two colleges outside of the Company, and pledged $37 million in company funds to secure loans unrelated to ChinaCast’s business.

Afterwards, Chan and ChinaCast’s CFO Antonio Sena failed to disclose this critical information to investors. Instead, through a series of earnings calls and SEC filings, they assured the market of ChinaCast’s financial stability and sound accounting controls. When the extent of the scheme was finally uncovered in early 2012, ChinaCast’s Board of Directors removed Chan as CEO, and Sena stepped down. Several class action suits were commenced on behalf of investors in the Central District of California in September 2012, and Pomerantz was appointed Lead Counsel for the class.

The district court dismissed plaintiff’s claims on the grounds that scienter, a “bedrock requirement” of a suit brought under Section 10(b) of the Securities Exchange Act of 1934, was not adequately pled against ChinaCast. Scienter requires a plaintiff to plead facts creating a “strong inference” that the corporation acted with “intent to deceive, manipulate, or defraud.” The district court found that the actions and intentions of Chan and his accomplices, however detestable, could not be imputed to ChinaCast under the “adverse interest” rule.

The general rule in securities fraud cases is that a corporate executive’s scienter is imputed to the company, as the company can only act, and formulate intent, through its employees. Where the executive is high enough in the corporate hierarchy, such as CEO Chan was here, his knowledge is the knowledge of the company. However, the adverse interest exception precludes imputation of knowledge where the employee acts solely in his own interest, injuring the corporation. The district court held that Chan’s frauds benefited himself at the expense of the corporation, and therefore satisfied the adverse interest exception to the imputation rule.

On appeal, the Ninth Circuit reversed this ruling. Pomerantz managing partner Marc Gross persuaded the court that a longstanding exception to the adverse interest exception applied. Known as the “apparent authority” or “innocent third party” exception to the exception, this doctrine “holds where a person reasonably relies upon the apparent authority of an agent, that misconduct of the agent is therefore imputed to the corporation, in this case the CEO and the company,” even if the misconduct is detrimental to the company. Pomerantz argued that imputing knowledge when innocent third parties are involved advances public policy goals in that it is the company that has selected and delegated responsibility to its executives, the doctrine creates incentives for corporations to do so carefully and responsibly.

The Ninth Circuit agreed, holding that “the adverse interest rule collapses in the face of an innocent third party who relies on the agent’s apparent authority.” In other words, a corporation can be held liable to investors even where officer’s actions are adverse to that corporation’s interest when they rely in good faith on that officer’s representations.”

The Ninth Circuit’s opinion is significant because it adopts a bright-light rule where, on a well-pled complaint, “having a clean hands plaintiff eliminates the adverse interest exception in fraud on the market suits because a bona fide plaintiff will always be an innocent third party.”

Managing Partner Marc Gross, who argued before the Ninth Circuit panel, stated that Pomerantz is “very pleased that the Ninth Circuit has made clear that corporations are accountable for defrauding investors, as they should be, even when the company’s own coffers have been looted by its own officers. After all, the corporation hired the officers and should be held responsible for how their misconduct impacts innocent investors."

The Importance of Being Advanced

ATTORNEY: GUSTAVO F. BRUCKNER
POMERANTZ MONITOR SEPTEMBER/OCTOBER 2015

Delaware is the state of incorporation for over 50% of all publicly traded corporations in the United States and 60% of the Fortune 500 companies. Delaware court decisions on issues of corporate law thus have far-reaching ramifications. A series of cases involving the rights of corporate directors for advancement and indemnification of legal fees shows just how important these rights are considered, even when they involve corporate wrongdoers. When a director is sued for his actions as a director, he may be entitled not only to be reimbursed for his defense costs after the case is over, but to have these costs paid immediately, even before there is a determination as to whether the case has merit and before it is decided whether or not he should be indemnified.

Although a seat on a corporate Board of Directors can be prestigious and often lucrative, it carries with it certain risks -- including the risk of liability for breaching fiduciary duties. Yet, because directors are not usually executives, they don’t always have the same level of involvement and awareness of the affairs of a company that day-to-day management has. Generally, the Business Judgment Rule protects a director from personal liability to the corporation and its stockholders for an unwise corporate decision so long as the director acted in good faith, was reasonably informed and believed the action taken was in the best interests of the corporation. Delaware General Corporation Law section 145 provides that corporations shall indemnify officers and directors (that is, pick up their defense costs incurred in successfully defending claims of corporate governance breaches). The Delaware courts have previously held that “the statute requires a corporation to indemnify a person who was made a party to a proceeding by reason of his service  to the corporation and has achieved success on the merits or otherwise in that proceeding [mandatory indemnification]. At the other end of the spectrum, the statute prohibits a corporation from indemnifying a corporate official who was not successful in the underlying proceeding and has acted, essentially, in bad faith.” In between, a corporation has the flexibility to indemnify its officers and directors, if they acted in good faith and without a reasonable belief that their conduct was criminal (permissive indemnification).

Since these costs cannot be determined until after the case is over, Delaware has also allowed corporations to agree to advance defense costs to officers and directors who find themselves defendants in such cases. This is seen as a way to attract top talent otherwise frightened of potential litigation. The advancement is usually subject to an “undertaking” by the director to repay any advancement if the director is ultimately not found to be entitled to indemnification. The law allows a corporation more latitude to provide advancement to current officers, but allows more conditions to be imposed on the benefit granted to former directors and officers, thus making an important distinction between current and former officers.

In Holley v. Nipro Diagnostics, Inc., the Delaware Chancery Court affirmed last year how seriously it takes these obligations to advance defense costs. Holley was the founder and Chairman of a medical device manufacturer, Home Diagnostics, that was acquired by Nipro in 2010. Pursuant to the acquisition, Nipro assumed Home Diagnostics’ advancement obligations to Holley “to the maximum extent permitted under the General Corporate Law of Delaware” for the costs of defending claims asserted against Holley “by reason of the fact” that he was a director of the Company. Soon after the merger closed, the SEC began an investigation into insider trading and initiated a civil enforcement action against Holley for disclosing non-public information to friends and family. Holley sought and received advancement of defense costs related to the SEC investigation. A month later, Holley was indicted on charges of criminal securities fraud. The SEC civil action was stayed pending resolution of the criminal action. After successfully getting the court to dismiss two of the criminal counts, Holley pled guilty to two additional counts and in exchange the government agreed to dismiss the three remaining counts. Thereafter the SEC civil enforcement action resumed and Holley sought advancement of his costs of defending that action. When Nipro refused, Holley brought suit.

Nipro argued that Holley was not entitled to advancement for the following reasons: he was not a party to the SEC enforcement action “by reason of the fact” that he was a director, but rather due to personal misconduct; since he pled guilty to insider trading he could not be indemnified and thus advancement would not be permissible; and public policy grounds. The Court rejected Nipro’s arguments. First, the Court found that the SEC investigation focused on the breadth and depth of inside information Holley possessed as a result of his position. The Court also held that “in advancement cases, the line between being sued in one’s personal capacity and one’s corporate capacity generally is drawn in favor of advancement with disputes as to the ultimate entitlement to retain advanced funds being resolved later at the indemnification stage.” The Court made clear that the right to advancement is separate and apart from the right to indemnification, with the right to advancement not dependent on the right to indemnification.  Nevertheless, the Court held that notwithstanding the guilty plea, Holley might be entitled to indemnification since the guilty plea did not necessarily preclude success on the SEC claims, which alleged misconduct beyond that encompassed in his guilty plea. The Court rejected the public policy arguments on the same grounds. To emphasize the importance of this issue, the Court also awarded Holley the fees incurred in litigating his advancement claims.

A few months later the Chancery Court once again reached the same conclusion in Blankenship v. Alpha Appalachia Holdings, Inc. Blankenship was CEO and Chairman of Massey Energy Company when a massive explosion at one of Massey’s mines killed twenty-nine miners. Blankenship retired soon thereafter and Massey was acquired by Alpha Natural Resources. As part of the merger, Massey asked Blankenship to sign a new undertaking which added language that Massey’s advancement of expenses was contingent upon Blankenship’s representation that he “had no reasonable cause to believe that his conduct was ever unlawful.” After the merger, Blankenship incurred legal expenses, which Massey paid, arising out of the government’s investigation of the mine explosion. When the government later criminally indicted Blankenship, Massey and Alpha determined that Blankenship breached his undertaking and ceased advancing the costs of his defense. Blankenship brought suit and, in a post-trial opinion, the Court found in his favor. Emphasizing the importance of advancement, the first sentence of the opinion states, “this advancement action involves some unusual facts but an all too common scenario: the termination of mandatory advancement to a former director and officer when trial is approaching and it is needed most.” The Court went on to find that the revised undertaking could not justify terminating advancement in the middle of Blankenship’s defense. Massey’s advancement obligations to Blankenship under its charter survived Alpha’s acquisition of Massey under the terms of the Merger Agreement between those parties. Because Massey’s charter required it to advance costs to the maximum extent provided by Delaware law, Massey could not then condition its advancement obligations on anything other than an undertaking to repay the expenses if it is later determined that indemnification is not appropriate. The Court also awarded Blankenship his reasonable expenses incurred in litigating the advancement action. These results comport with a spate of cases since Holley involving claims for advancement that have ended with similar results.

Most recently the court did find there are limits to advancement, in two cases over two consecutive weeks. In Lieberman v. Electrolytic Ozone, the Chancery court found that post-employment conduct did not entitle former officers to advancement. Lieberman and Lutz were the CEO and VP Engineering, respectively, of Electrolytic Ozone. They had signed non-disclosure and non-compete agreements. In December 2013 they were terminated as part of a consolidation of operations. Electrolytic also terminated a 10-year supply contract with Franke Foodservice Systems two years into the contract. Franke initiated arbitration against Electrolytic for breach of the supply agreement. Lieberman and Lutz went to work for Franke in February 2014. In June 2014, Electrolytic raised third-party claims against Lieberman and Lutz for breach of their employment, non-disclosure and non-compete agreements.

Lieberman and Lutz brought suit after Electrolytic refused to provide them advancement. The Court held that Lieberman and Lutz could only be entitled to advancement of fees for litigation brought “by reason of the fact” that they served as EOI directors, officers or employees. Although the Court said the test is broadly construed, it found that the “arbitration claims are confined to post-termination actions and do not depend on [Lieberman and Lutz’s] use of corporate authority or position.” The Court went on to note that Electrolytic’s contractual claims were derived from specific contractual obligations that were allegedly breached post-termination. Thus Lieberman and Lutz were not entitled to advancement.

In Charney v. American Apparel, Inc., the Court held that the permissive indemnification written into a post-employment standstill agreement was not as broad as the indemnification
granted under the law. Charney, founder and former CEO/chairman of American Apparel, was forced out of the company after revelations of sexual harassment and initiation of lawsuits emanating from such allegations. He was suspended as the company’s chief executive officer in June 2014, resigned as a director of the company in July 2014 and was terminated for cause as CEO in December 2014. Thereafter, the company brought suit against Charney, alleging that after he was no longer CEO he violated the nomination, standstill and support agreement under which he agreed to not disparage the company or to run a proxy contest for the company’s board of directors. Charney sought advancement of his legal expenses in defending against the case under an indemnification agreement he had with American Apparel, which mandates the advancement of legal costs “related to the fact” that Charney was a director or officer of the company.

The Court concluded that these claims did not involve any alleged “use or abuse of corporate power as a fiduciary of American Apparel,” and thus Charney could not be entitled to indemnification under the terms of the contract. Additionally, the company’s charter only mandates advancement for current officers and directors. Therefore, the Court found that Charney could not receive advancement.

However, the facts in Charney and Lieberman differ from most advancement cases in that the questionable conduct occurred when those seeking advancement were no longer directly employed by the company. In contrast, Blankenship sought advancement when he was no longer employed by the company but it was to defend conduct that occurred while he was still employed. And as Holley v. Nipro shows, even criminal behavior may not be sufficient to preclude advancement.

District Court Upholds Our Claims Against Galena Biopharma

ATTORNEY: JENNIFER BANNER SOBERS
POMERANTZ MONITOR SEPTEMBER/OCTOBER 2015

In August, Pomerantz won an important victory for investors against Galena Biopharma, certain of its officers and directors, and others when the district court of Oregon largely rejected defendants’ motion to dismiss the action. 

The complaint alleges that defendants manipulated the market price of Galena stock when Galena hired Dream-Team, a promotional consulting company, to publish bullish articles to inflate Galena’s stock. According to the complaint, DreamTeam published articles on websites touting Galena and falsely claiming that the articles were written by established, credible investment professionals, whereas in fact the articles were paid promotions using a variety of aliases for the “authors”. Investors reading the many varied web and social media positive postings about Galena could conceivably be convinced that they should invest in the company. While Galena stock was being pumped up, Galena’s officers dumped large amounts of company stock, reaping enormous profits. In short, this was a classic “pump and dump” scheme.

Defendants’ motion to dismiss relied primarily on the argument that under a recent Supreme Court case, Janus Cap. Grp. Inc. v. First Derivative Traders, only the “maker” of a statement can be held liable for alleged misrepresentations and omissions in violation of the securities laws. Here, they claimed, only the individual authors of the articles hired by the third party stock promoters were “makers” of these statements In response, we argued that, under Janus, the maker of a statement is not just the person identified as the author, but the person or entity with ultimate authority over the content and communication of the statement. Since Galena officers had final authority over the articles and had to approve the content before they were published, Galena and its officers were the “makers” of the allegedly false statements. 

The District Court agreed with us and refused to extend the holding of Janus to say that only the individual authors were “makers” of the statements. The Court noted that if it were to consider the individual authors as the makers of those statements, then companies could avoid liability under the securities laws by paying third parties to write and publish false or misleading statements about the company, even when the company retains final decision    making authority over content.

Defendants also argued that the articles were written by and attributed to the individual authors, and under Janus, the attribution within the articles serves to prove that the authors are the “makers” of the statements. The District Court did not agree. The Supreme Court in Janus noted that in the “ordinary case” attribution within a statement is strong evidence that the statement was made by the party to whom it is attributed. However, the District Court found that this case is not ordinary and attributions under false aliases like “Kingmaker” and “Wonderful Wizard” are meaningless, as no reasonable reader would believe that the statements were made by people with those names. Moreover, the purported biographies associated with the author aliases were allegedly false. Thus, the District Court found that the attribution was not strong evidence that the false aliases were the “makers” of statements contained in the articles.

However, the District Court did hold that Galena, as the only party that had ultimate authority over the published articles, was the maker of these statements, and not also the DreamTeam as we argued. The Court noted that the lesson of Janus is that where legally distinct entities are involved, only one entity has the final say in what, if anything, is published.

Defendants’ motion to dismiss also invoked the so-called “truth on the market defense,” arguing that defendants’ alleged misstatements could not have been material because corrective information was already disclosed to the market. This “corrective” information was supposedly revealed by an obscure website, which disclosed that one of the stock promoters touting the company was receiving compensation from Galena.

The District Court rejected that argument, holding that it is not reasonable for investors to have to research every stock promotion-related website to make sure that each company recommended by purportedly independent analysts and investors has not hired a promotional firm to engage in secret stock promotions. Moreover, as alleged in the complaint, further evidence that the paid promotional campaign was not already incorporated into Galena’s stock price was that after articles revealing the fraudulent scheme were published, the company’s stock price dropped significantly. Defendants in securities cases often attempt to rebut materiality allegations by showing that corrective information was published on some obscure website or in an article that is not widely circulated. Thus, the District Court’s finding on this point is an important victory for investors.

Update: Another Go-Around For Loss Causation In The Ninth Circuit

ATTORNEY: MICHELE S. CARINO
POMERANTZ MONITOR SEPTEMBER/OCTOBER 2015

Ten years ago, in its seminal decision in Dura Pharmaceuticals, Inc. v. Broudo, the Supreme Court held that in a securities fraud case the plaintiffs must allege facts establishing “loss causation,” meaning that the misrepresented or omitted facts actually caused losses for investors. This can occur, for example, when the company makes a “corrective disclosure” that reveals new or previously concealed information concerning the true state of the company’s affairs, which then causes the price of its stock to drop.

Since then, there has been a great deal of discussion as to how to apply the Dura rule, especially in cases where there has not been a single, or obvious, corrective disclosure. Recently, the Ninth Circuit has been asked to provide  some much-needed clarity in this area.

In August, in Smilovits v. First Solar Inc., a federal district court in Arizona certified for immediate interlocutory appeal the issue of the correct standard to apply for pleading loss causation in cases where the company does not explicitly “correct” any previous disclosures – i.e. admit that they were false or misleading. In such cases, two conflicting standards have emerged in the Ninth Circuit post-Dura, which the district court concluded would yield contradictory results in the case before it. First Solar involves allegations that the defendants withheld information about certain manufacturing defects in their products. Eventually, those defects started to affect the company’s financial condition, and its stock began to decline, falling from nearly $300 per share to less than $50 per share. Plaintiff identified six stock price declines following announcements of disappointing financial results. Although plaintiff claimed that the poor results were actually caused by these undisclosed manufacturing defects, the company did not admit it.

Applying the test articulated in Nuveen Mun. High Income Opportunity Fund v. City of Alameda, plaintiff contended that loss causation is satisfied “by showing that the defendant misrepresented or omitted the very facts that were a substantial factor in causing the plaintiff’s economic loss.” On the other hand, defendants urged the court to adopt a much narrower view, which would require not only that the misrepresented or omitted facts caused the loss, but that the company admitted that its previous statements were wrong.

In support of this argument, defendants relied on another line of Ninth Circuit case law beginning with Metzler Investment GMBH v. Corinthian Colleges, Inc. The Metzler line of cases requires a showing that “the market learn[ed] of a defendant’s fraudulent act or practice, the market react[ed] to the fraudulent act or practice, and plaintiff suffer[ed] a loss as a result of the market’s reaction.” According to defendants, since First Solar’s poor earnings announcements were not accompanied by any revelation of a prior fraud, plaintiff could not demonstrate the requisite “causal connection” between defendants’ alleged misrepresentation or omission and plaintiff’s loss.

The district court ultimately determined that Nuveen stated the better rule, holding that the requirements of proximate cause are satisfied so long as the misrepresented fact led to the plaintiff’s loss. Thus, it does not matter whether the company reveals that it has committed a fraud. As the district court explained: “If the plaintiff can prove that the drop in revenue was caused by the misrepresented fact and that the drop in his or her stock value was due to the disappointing revenues, the plaintiff should be able to recover. A causal connection between the ‘very fact’ misrepresented and the plaintiff’s loss has been established.”

An affirmance in First Solar by the Ninth Circuit potentially would have far-reaching implications, because it would prevent companies from averting liability simply by refusing to admit that misstatements had been made. It might also put an end to the ongoing dispute over whether the announcement of governmental investigation, followed by a drop in a company’s stock price, satisfies the loss causation test under Dura. The Ninth Circuit has adopted the reasoning in Loos v. Immersion, which like Metzler, holds that disclosure of an investigation is insufficient to establish loss causation, because “[t]he announcement of an investigation does not ‘reveal’ fraudulent practices to the market,” but only the possibility that a fraud may have occurred. Loos requires something “more” – presumably, some revelation or actual accusation of fraud. However, as the First Solar court recognized, application of Nuveen in cases like Loos yields a completely different outcome, so long as plaintiffs establish that the ‘very fact’ misrepresented, e.g., the undisclosed fraudulent conduct prompting the investigation, caused the stock to decline in value.

The First Solar approach also makes eminent sense as a policy matter. Requiring revelation of fraud before losses are actionable rewards defendants who issue bare bones disclosures or time the announcement of poor financial results to coincide with other events, even though they may have knowledge of the real causes of the company’s difficulties. When and if an actual fraud is revealed, there may be no subsequent price decline, as the market has already incorporated and accounted for the previously-disclosed bad news, and therefore, there is no actionable corrective disclosure. Thus, defendants who succeed at concealing fraud are most likely to be insulated from liability. That is the exact opposite result sought to be achieved by the federal securities laws. We will have to wait to see if the Ninth Circuit agrees.

Leakage Theory is No Longer Just a Theory

ATTORNEY: MICHAEL J. WERNKE
POMERANTZ MONITOR SEPTEMBER/OCTOBER 2015

It all started ten years ago with a question posed by  Justice Stevens during oral arguments in Dura Pharm., Inc. v. Broudo: “What if the information leaks out and there’s no specific one disclosure that does it all and the stock gradually declines over a period of six months?” Until last month, this question remained in the “what if” category of securities fraud jurisprudence. We now have an answer. In Dura, the Supreme Court held that a plaintiff in a securities fraud action must plead the element of loss causation, i.e. that the company’s stock price declined once the truth was revealed through a corrective disclosure. At trial, the plaintiff must ultimately prove that the decline in stock price was a result of the fraud – not market, industry or company-specific nonfraud factors. Since Dura, courts have universally held that loss causation can be established even if the truth is revealed through multiple “partial” corrective disclosures that drove the stock price down.

Courts have also acknowledged that, in theory, a company’s stock price could decline as a result of the truth “leaking” into the market without any actual disclosures of the fraud. For example, the stock price may move because insiders traded on the inside fraud related information prior to a disclosure, or because investors gradually lost confidence in the company’s previous misrepresentations even though the truth was not yet officially disclosed. However, in practice, courts have until now required plaintiffs to connect any decline in stock price to an identifiable “corrective” disclosure. 

The Seventh Circuit’s June 21, 2015 decision in Glickenhaus & Co. v. Household International, Inc. has lifted that restriction, creating the possibility that investors may recover losses resulting from the gradual decline in a company’s stock price that is not directly connected to any corrective disclosure, but which can be attributed indirectly to the unraveling of the underlying fraud. 

In Household, the defendants appealed to the Seventh Circuit a jury verdict finding them liable for securities fraud on the basis that the causation/damages model adopted by the jury failed to establish loss causation. The plaintiffs had presented two models to the jury. The first, a “Specific Disclosure Model,” identified fourteen partial corrective disclosures that revealed the truth to the market and calculated the price declines that followed within the next day, removing price movements attributable to market and industry factors. This model determined that disclosure of the fraud led directly to investor losses of $7.97 per share. The second analysis, the “Leakage Model,” attributed to the fraud all the price declines during the year-long period of partial disclosures, except for declines caused by market or industry factors. Using this model, plaintiffs calculated that losses per share were $23.94. The jury adopted the Leakage Model and damages were ultimately determined to be $2.46 billion.

In their appeal, the defendants argued that the Leakage Model was flawed because it included price declines that did not immediately follow any of the partial disclosures of the fraud. While the Leakage Model eliminated market and industry factors, it did not identify and eliminate the effect of company-specific, nonfraud news on the stock price, which may have contributed to the decline in stock price during the periods between the fourteen partial corrective disclosures. Instead, plaintiff’s expert testified in general terms that he considered the issue but was unable to conclude that non-fraud news would have altered the analysis. The question before the court was whether that was enough or whether the model itself must fully account
for the possibility that company-specific, nonfraud factors affected the stock price.

The court refused to answer simply “yes” or “no,” as doing so would create an unfair advantage for plaintiffs or defendants. Accepting the defendants’ position would likely doom the leakage theory because it may be “very difficult, if not impossible,” for any statistical model to separate damage caused by “leakage” from damage caused by release of company-specific news unrelated to the fraud. On the other hand, if it’s enough for an expert to offer a conclusory opinion that no company-specific, nonfraud related information affected the stock price, then plaintiffs may be able to easily evade their burden of proving that the loss for which they seek recovery was a result only of the alleged fraud.

The court chose a middle ground, creating burden-shifting process to be used at trial. It held that if the plaintiffs’ expert testifies in a nonconclusory fashion that no company-specific, nonfraud related information contributed to the decline in stock price, then the burden shifts to the defendants to identify some significant, company-specific, nonfraud related information
that could have affected the stock price. If the defendants can, then the burden shifts back to the plaintiffs to account for that specific information or provide a model that doesn’t suffer from the same problem. Significantly, the court stated that one solution for the plaintiffs would be to simply exclude from the model’s calculation any stock price movements directly related to the company-specific nonfraud information identified by the defendants. 

While the defendants won the battle – the case was remanded to the trial court – investors may have won the war. Plaintiffs’ recoveries in a securities fraud action are no longer limited to stock price declines immediately following specific disclosures of the fraud. Moreover, the
Seventh Circuit provided a clear roadmap for the creation and use of a leakage model that can withstand judicial scrutiny (at least in the Seventh Circuit). 

Notably, this decision came only a year after the Supreme Court’s decision in Halliburton II, which dialed back the more rigid views of market efficiency which had previously been employed by many of the lower courts, and installed a similar burden-shifting process for that analysis. The Seventh Circuit’s decision could be viewed as a road marker in a forming trend of courts taking a more practical view of how securities markets function and investors’ burdens in proving their losses from frauds.

Ninth Circuit Refuses to Follow Second Circuit's Insider Trading Decision

ATTORNEY: LEIGH HANDELMAN SMOLLAR
POMERANTZ MONITOR JULY/AUGUST 2015

In a controversial decision written by Manhattan U.S. District Judge Rakoff, sitting by designation, the 9th Circuit recently upheld an insider trading conviction and, in the process, refused to follow the standard established by the Second Circuit in its Newman opinion decided in 2014. That case made it more difficult to convict recipients of inside information (“tippees”) by requiring the govern-ment to show that the tippee was not only aware that the information came from a corporate insider, but also that he or she knew that the insider (the “tipper”) had received a tangible benefit in exchange for leaking the information, a benefit that was “objective, consequential and rep-resents at least a potential gain of a pecuniary or similarly valuable nature.” Newman rejects the theory that leaking to enhance a personal, family or business relationship satisfies the personal benefit requirement. Several guilty pleas obtained from tippees were overturned based on the decision.

The Newman case involved tippees who were several layers removed from the tipper’s original disclosure of inside information. When inside information is passed around an investment firm, for example, it may be difficult to prove that someone way down the information food chain was aware of the original source of the leak and that the tipper had received a personal benefit.

In U.S. v. Salman, decided July 6, 2015, the 9th Circuit has refused to follow Newman. In that case Salman’s brother- in-law leaked inside information to his own brother, who in turn, shared that information with Salman. The evidence at trial showed that Salman knew that his brother-in-law was the original source of the inside information.

But the evidence also showed that Salman did not know about any tangible economic benefit received by his brother-in-law in exchange for leaking the information.

But the 9th Circuit disagreed with the Second Circuit in Newman and affirmed the conviction anyway. The court held that the “personal benefit” requirement did not require that the tipper receive a financial quid pro quo. Instead, it held that it was enough that Salman “could readily have inferred [his brother-in-law’s] intent to benefit [his brother].” In declining to follow Newman, the court noted that if the standard required that the tipper received something more than the chance to benefit a close family member, a tipper could provide material non- public information to family members to trade on as long as the tipper “asked for no tangible compensation in return.”

Are Airlines Conspiring to Keep Prices High?

ATTORNEY: JAYNE A. GOLDSTEIN
POMERANTZ MONITOR JULY/AUGUST 2015

Since 1978, when Congress enacted the Airline Deregulation Act (“ADA”), the domestic airline industry has been deregulated. The Act did away with govern-mental control over fares, routes and market entry of new airlines, leaving market forces to dictate these aspects of the industry, and causing the airlines to compete over fares, routes and seats.

Times have changed. Since 2005, with the merger of US Airways and America West, the airline industry has been significantly consolidated. The Delta and Northwest merger followed in 2008, the United and Continental merger in 2010, and the Southwest and AirTran merger in 2011. Most recently, American and US Airways merged in 2013, creating the biggest airline in the world. Today, American, United, Southwest and Delta account for over 80% of the domestic airline market. So much concentration of market power makes it easier for the few remaining behemoth competitors to rig the market.

On June 11, 2015, the New York Times published the article, “‘Discipline’ for Airlines, Pain for Fliers,” in which it revealed that airlines had discussed maintaining “discipline” at a recent industry conference at the International Air Transport Association (“IATA”) held in Miami earlier that month. “Discipline” in this context is a euphemism for limiting flights and seats, raising prices and increasing profit margins. At the meeting, Delta Airline’s president, Ed Bastian, stated that Delta was “continuing with the discipline that the market place is expecting.” Also at this meeting, American Airlines’ chief, Dough Parker, stated that the airlines had learned their lessons from past price wars: “I think everybody in the industry understands that,” he told Reuters. In May 2015, Defendant Southwest’s chief executive, Gary C. Kelly, had considered breaking ranks and announced that Southwest would expand capacity in 2015-2016 by as much as 8 percent. However, after coming under fire at the IATA conference in June 2015, Mr. Kelly changed his position, stating, “We have taken steps this week to begin pulling down our second half 2015 to manage our 2015 capacity growth, year-over- year, to approximately 7 percent.”

The “discipline” is paying off; it is projected that airline industry profits will more than double in 2015, to a record nearly $30 billion. When airlines (or other companies) collude to restrict capacity in their routes and seats, they are subject to violating the antitrust laws. When companies are not competing in the marketplace, consumers foot the bill with high prices.

Several senators called for a federal investigation of U.S. airline prices, which have not come down, despite the fact that the price of jet fuel has fallen dramatically. In mid-June, Senator Richard Blumenthal (D-Conn.) asked the Department of Justice to investigate possible collusion and anti-competitive behavior by U.S. airline companies following the meeting of top executives at the IATA annual conference. It appears that the Department of Justice heard the senators’ requests, and is now investigating whether American, United, Southwest and Delta colluded to restrain capacity and drive up fares, an antitrust violation. On July 1, 2015, the airlines confirmed that the DOJ had requested information from them about capacity and other matters.

In the wake of alleged collusion among the airlines, numerous lawsuits have been filed. On July 10, 2015, Pomerantz instituted an antitrust class action on behalf of direct purchasers of airline tickets against American, United, Southwest and Delta. The case is pending in the Northern District of Illinois.

Our Walter Case Survives Motion To Dismiss

ATTORNEY: MURIELLE STEVENS WALSH
POMERANTZ MONITOR JULY/AUGUST 2015

Judge Ungaro of the U.S. District Court for the Southern District of Florida has recently denied the motion to dismiss our complaint against Walter Investment Management and several of its officers.

The case alleges that the defendants misrepresented that the company had sound internal controls and was in compliance with federal regulations regarding mortgage servicing, when in fact one of the company’s primary subsidiaries, Green Tree Servicing, had engaged in rampant violations of federal consumer laws. Walter’s stock price declined when the company revealed that the government was investigating it for these violations. Defendants initially moved to dismiss our original complaint, arguing that the disclosure of the investigation was not enough to establish loss causation, a requirement for a securities fraud claim. The court agreed, because under applicable 11th Circuit standards, the disclosure of a government investigation and possible government action, standing alone, were not enough to establish loss causation. The theory is that an investigation means that there is merely some possibility that violations had occurred, which the court held is not certain enough to amount to a “corrective disclosure” that the company’s statements about legal compliance were wrong. The court did, however, grant us leave to amend the complaint.

Our second amended complaint included the new allegation that the government announced that it had decided to bring an enforcement action against the company to seek injunctive relief and fines. Importantly, analysts factored this development into their price target for Walter stock. We included these facts in our amended complaint; and the judge found that this disclosure was sufficient to establish loss causation – even though the initiation of a lawsuit by itself is not tantamount to a “corrective disclosure” either, because the company still could prevail at trial. But the Court held that the bringing of the government action moved the potential losses much closer to reality.

Ultimately, the company settled the government case, agreeing to injunctive relief and the payment of fines. 

Whether disclosure of an investigation satisfies the “loss causation” requirement is a contentious issue in securities fraud litigation. Typically, it is such disclosures that actually trigger most of the losses; after that point, the market factors into the market price much of the risk of eventual litigation and its consequences.

Omnicare

ATTORNEYS: JESSICA N. DELL AND H. ADAM PRUSSIN
POMERANTZ MONITOR JULY/AUGUST 2015

In March, the Supreme Court, in a case called Omnicare, tackled the issue of when statements of opinion that appear in a registration statement can violate Section 11 of the Securities Act. Section 11 creates a private right of action for investors who purchased shares in an initial public offering when the registration statement contained materially false or misleading information. Unlike theantifraud provisions of the Exchange Act, Section 11 does not require that the investor show that the issuer, or the directors who signed the registration statement, had a culpable state of mind. If the registration statement was wrong, defendants are liable. The company is subject to strict liability; the directors can escape liability only if they can establish an affirmative defense.

In Omnicare the registration statement expressed the belief that the rebates Omnicare was receiving from suppliers were legal. In its decision below, the Sixth Circuit had held that under Section 11 a statement of opinion or belief can violate Section 11 if the opinion or belief turned out to be wrong – even if the issuer and its directors sincerely believed it at the time.

The Supreme Court rejected that view, holding that statements of opinion or belief are not “misstatements of fact” for purposes of Section 11. “Most important, a statement of fact (‘the coffee is hot’) expresses certainty about a thing, whereas a statement of opinion (‘I think the coffee is hot’) does not.” Because statements of opinion do not convey certainty about the subject, the Court rejected the contention that an expression of opinion or belief can be a misstatement of fact simply because it turned out to be wrong. Instead, the Court held that beliefs or opinions can be misstatements of fact only if the issuer did not really believe them at the time. While opinions themselves may be subjective, whether one holds them or not is an objective fact. In Omnicare, defendants clearly believed what they had said, so there was no misstatement of fact.

But the Court’s opinion did not stop there. It also held that a reasonable investor is entitled to assume that the issuer had a basis for the opinion or belief it is conveying. For example, if the issuer says that it believes that certain of its business practices are in compliance with applicable law, as Omnicare did here, it would also have to disclose whether it had formed that belief without consulting a lawyer, or if its lawyers had given contrary advice. Omissions can render those statements misleading if “the investor … identifies particular (and material) facts going to the basis for the issuer’s opinion—facts about the inquiry the issuer did or did not conduct or the knowledge it did or did not have—whose omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context.”

This issue is going to be the focus of future litigation over Section 11 liability for statements of opinion or belief. What type of foundation can investors reasonably assume a company has for such statements, and what qualifies as a material fact that had to be disclosed because it might undermine that assumed foundation? Time will tell.

Petrobras: The Whole Barrel is Tainted, Not Just Four Rotten Apples

ATTORNEY: JUSTIN NEMATZADEH
POMERANTZ MONITOR JULY/AUGUST 2015

On July 9, 2015, Pomerantz won a significant victory for investors against Petrobras, the Brazilian energy giant, and four of its senior executives, when the district court rejected defendants’ motion to dismiss the action. For years Petrobras has been embroiled in a massive scandal, as prosecutors there have been pursuing the largest corruption investigation in that country’s history.In 2009 Petrobras had a market capitalization of $310 billion; now, since this massive scheme came to light, itis down to $55 billion. As the Monitor previously reported, the scheme involved overcharging Petrobras for goods and services, with the excessive payments being used to bribe a host of Petrobras and government officials.This scheme was allegedly orchestrated by four Petrobras officials, all of whom are defendants in our action.

The heart of the company’s motion was its contention that scienter, or knowledge, of the wrongdoing was limited to four “rogue” officers of the company, and that their knowledge cannot be “imputed,” or attributed, to the company, under the so-called “adverse interest” theory. Normally, a company is deemed to know what its senior executives know; but if those executives are acting for their own personal interests, and contrary to the interests of their company, they are acting outside the scope of their employment and their knowledge is not imputed to the company. Here, defendants argued that the officers’conduct was adverse to the company’s interests because the scheme diverted cash from the company, as a result of the overcharges the company paid, and into the pockets of the four individual defendants and various corrupt politicians and other conspirators. In addition, by artificially inflating asset values on Petrobras’ balance sheet,defendants argued that the individuals harmed the company by causing it to pay excessive prices that were reflected in the carrying value of those assets.

But, as senior Pomerantz partner Jeremy Lieberman explained to the Court at the hearing on the motion to dismiss, knowledge of the scheme was not limited to the four “rotten apples,” but was, in fact, widely disseminated in the company. Most notably, perhaps, he highlighted evidence showing that the Petrobras board was aware of the over billing scheme. Moreover, he argued that the adverse interest exception applies only when the company receives no benefit what-soever from the misconduct. Here,in contrast, the beneficiaries of the scheme were officials of the Brazilian government – which owns 51% of Petrobras’ stock. Moreover, by failing to correct the company’s fraudulent financial statements,the defendants were benefiting Petrobras by avoiding a massive write-down of the company’s assets.

Defendants also argued that the scheme was immaterial because its payments to contractors were inflated by only 3% and that the four conspirators received kickbacks amounting to a small portion of this 3%. As a result, when the scheme was disclosed Petrobras was forced to write off only $2.5 billion of property, plant and equipment on its balance sheet, about 8% of the total assets. In fact, however, our well-founded allegations showed that Petrobras was over billed by about 20%, not 3%, and that the $2.5 billion write-down reflected only a small fraction of the actual impact of the fraudulent scheme.

Delaware Ban on Fee-Shifting ByLaws Signed Into Law

ATTORNEY: SAMUEL J. ADAMS
POMERANTZ MONITOR JULY/AUGUST 2015

In a victory for shareholder rights, Delaware’s Governor recently signed into law a bill that prohibits fee-shifting bylaws for Delaware-incorporated publicly traded corporations. The bill was passed in response to a growing number of Delaware stock corporations that had recently begun adopting fee-shifting provisions that sought to pass defense costs on to unsuccessful shareholder plaintiffs or, in some cases, even plaintiffs that were only partly successful in a lawsuit for breach-es of fiduciary duty or other similar claims. Because shareholder plaintiffs – like plaintiffs in all other kinds of actions – almost never prevail on all counts asserted in a complaint, the specter of crushing financial liability from such bylaws threatened to choke off almost all shareholder litigation, regardless of the merits.

The increasing number of fee-shifting bylaws adopted by Delaware corporations stemmed from the Delaware Supreme Court’s decision last year in ATP Tour v. Deutscher Tennis Bund, which upheld a fee-shifting bylaw enacted by a private company. In that decision, the court held that a private Delaware corporation may adopt a bylaw which shifts all litigation expenses to a member plaintiff who does not obtain “a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought.” While the ATP court did not weigh in on whether such a bylaw would be permissible in the context of a public company, some public corporate boards of directors sensed an opening. With dozens of public companies adopting such fee-shifting provisions, action was needed by either the legislature or the judiciary in order to clarify the enforceability of these bylaws.

Earlier this year, prior to Delaware’s enactment of the fee-shifting bylaw prohibition, Pomerantz was on the vanguard of the fight against fee-shifting provisions in a case of first impression in Strougo v. Hollander. In that opinion, the first to address fee-shifting provisions following ATP, the Delaware Court of Chancery found that a fee-shifting bylaw was inapplicable to a share-holder plaintiff and the class where the bylaw was adopted after a plaintiff had been forcibly cashed out through a reverse stock split. While not explicitly ruling on the broader issue of the applicability of fee-shifting bylaws generally to public corporations, Chancellor Bouchard found that the bylaw in that instance did not apply to the shareholder plaintiff both because the bylaw was adopted after the plaintiff had been forcibly cashed out as a shareholder, and also because Delaware law does not authorize bylaws that regulate the rights or powers of a stockholder whose equity interest in a corporation had been eliminated before the bylaw was adopted.

In enacting the bill, the Delaware legislature recognized the chilling effect that fee-shifting bylaws would likely have on the ability of shareholders to voice certain challenges to corporations in court. Because many public companies chose to incorporate in Delaware, the Delaware courts and judiciary have a substantial influence on corporate governance. The synopsis of the bill itself states that the prohibition on fee-shifting provisions was enacted “in order to preserve the efficacy of the enforcement of fiduciary duties in stock corporations.” While many believed that the Delaware courts would have ultimately invalidated fee-shifting bylaws for public companies, the bill obviated the need for the courts to weigh in on the issue. As a consequence, shareholder plaintiffs can seek to hold corporate fiduciaries accountable without the risk of liability to corporate defendants for potentially millions of dollars in attorneys’ fees.

In a compromise, the recently-enacted bill also affirmed the enforceability of forum selection bylaws which seek to dictate the exclusive court in which plaintiffs may file certain types of shareholder litigation, such as those asserting claims for breaches of fiduciary duty. In many cases, shareholder plaintiff can elect to file such litigation in either a public company’s state of incorporation or the state of a corporation’s head- quarters. For Delaware public companies that wish to limit such litigation to a particular venue, the Delaware legislature clarified that such forum selection clauses are enforceable, so long as Delaware is selected as the exclusive forum for such litigation.

Pomerantz Shatters the Glass Ceiling

POMERANTZ MONITOR, MAY/JUNE 2015

 Pomerantz LLP is once again at the vanguard of the legal field. In a recent report, Law 360 has ranked the firm No. 1 in Top Law Firms for Women: Class Action Securities Firms. Pomerantz is proud to boast a 40% rate of female partners, 40% rate of female Of Counsel, and a 50% rate of female associates. These numbers put Pomerantz near the head of women overall in law firms in the United States, and at the forefront of women in class action securities firms in particular. 

Managing Partner Marc I. Gross shared his thoughts on this distinction, stating, “Pomerantz is proud that its efforts to maintain a diversified staff of attorneys and partners has been so successful. We hope other firms will follow.”
Pomerantz is no stranger to cutting edge accomplishments in the legal field, consistently finding new and innovative ways to fight for our clients’ rights; we are proud of this latest recognition of our success. At a time when the gender gap in America’s workforce is a source of national controversy, Pomerantz strongly stands by our hiring practices, which ensure the best attorneys are chosen for the job of representing our clients. 

Partner Murielle Steven Walsh says, “As a young associate at Pomerantz, I was mentored by a women partner. That experience had a positive impact on my development as an attorney.” Ms. Steven Walsh has prosecuted highly successful securities class action and corporate governance cases, and has argued, and won, cases before the Second Court of Appeals. 

Among recent accolades for Pomerantz attorneys, Partner Jayne Goldstein, who heads Pomerantz’s Florida office, was featured in a recent Law 360 article, “The Female Attorneys You Admire”; and Tamar A. Weinrib, Of Counsel, was chosen as a New York Metro Rising Star in 2014. 

Pomerantz looks forward to keep pushing the envelope in this arena and others as we continue the legacy our founder, Abe Pomerantz, began almost 80 years ago.