Intuit Shareholders and Directors Reject Forced Arbitration Proposal

ATTORNEY: JARED M. SCHNEIDER | POMERANTZ MONITOR MARCH/APRIL 2020

While ardent disputes between investors and management about conducting securities litigations might not be newsworthy, their rare agreements are. One such agreement occurred at the meeting of Intuit’s share­holders on January 23, 2020. Harvard Law’s Nomura Professor Emeritus Hal Scott, an activist for forced securities arbitrations, filed a shareholder proposal (as trustee of the Doris Behr 2012 Irrevocable Trust) that would have waived the right to bring class action claims against the company. Professor Scott wanted Intuit’s shareholders to be required to submit individual claims to mandatory arbitration in the event that Intuit violated the securities laws, instead of being able to file a class action in court.

Despite the proposal’s assurances that “arbitration is an effective alternative to class actions” that “can balance the rights of plaintiffs to bring federal securities law claims with cost-effective protections for the corporation and its stockholders,” Intuit’s board of directors ultimately recom­mended voting against the proposal, finding it “not in the best interest of Intuit or its shareholders.” Over 97.6% of Intuit’s shareholders agreed.

The overwhelming rejection of the mandatory arbitration proposal by Intuit’s board and shareholders makes sense. Forced arbitration is not the grand balancing of interests between these two groups that its supporters claim it to be, and instead harms shareholders, the broader market, and even the companies themselves.

For an individual investor, prosecuting a fraud claim against a public company is a remarkably expensive, risky, and time-consuming proposition. Under the Federal Rules of Civil Procedure, an ordinary plaintiff’s complaint is only required to contain a “short and plain statement” explaining why the plaintiff is entitled to relief. However, since 1995, the pleading requirements to allege a claim for securities fraud have favored management’s interests. To state a claim under the management-endorsed Private Securities Litigation Reform Act of 1995, victims of se­curities fraud must allege specific, particular facts about (a) which statements were false or misleading (including who made the statements, when they were made, and in what context they were made); (b) why those statements were false; and (c) a strong inference—at least as com­pelling as any competing inference—that the maker of the false statements knew, or was reckless in not knowing, that they were false.

By itself, establishing sufficient particular facts to allege that a statement is false presents a significant challenge. But requiring the investor to uncover additional facts es­tablishing that the company knew the statement was false, without the benefit of reviewing the company’s internal documents or speaking with its current employees, makes this challenge a high hurdle bordering on clairvoyance.

Prosecuting a securities fraud action is frequently a years-long, multi-million-dollar endeavor. Thus, if shareholders who were subject to forced arbitration became victims of a company’s securities fraud, only the company’s larg­est shareholders (i.e., its closest and most sophisticated investors) would be able to recover their losses through individualized mandatory arbitrations.

Beyond providing a way for investors to recover losses due to fraud, securities class actions are prophylactic, protect­ing both current stockholders and the broader market. Re­search indicates that, with all else being equal, a person is more likely to lie when there is a lower chance that they will be caught lying, or when the probable punishment (financial or reputational) is slight. A system that provides account­ability, like the current one for class action securities litiga­tion that enables private persons to uncover and prosecute fraud as well as recover their losses, serves as a deterrent and increases the likelihood of bringing fraudsters to justice over a system that does not (such as individualized manda­tory arbitration). Similarly, the specter of a damages judge­ment that encompasses the losses in all of a company’s public shares will act as a better deterrent than damages based off of a small percentage of those shares.

Aside from the enhanced deterring effect of class actions above individualized mandatory arbitrations, the nature of public litigation and the potential for appellate review forces judges to issue written and, ideally, well-reasoned decisions. These decisions form the body of law for securi­ties-fraud claims and help to define the contours and limits of permissible conduct. Private arbitrators, who are usually not subject to appellate review and issue confidential deci­sions, do not have the same motivation to issue reasoned decisions or to form precedence. Forced arbitration need­lessly increases uncertainty and risk in markets that are already uncertain and risky.

In various interviews, Professor Scott supposes that class actions for securities fraud actually hurt shareholders because such lawsuits merely move money from one group of shareholders to another. This sophistic analysis, however, is both wrong and misguided as it ignores the significant societal goods that attend a robust practice of litigating claims of securities fraud. Securities fraud suits are not the cause of the harm to the company’s current shareholders. The company’s fraud causes the harm and resulting destruction in value, not the subsequent efforts to recover investors’ losses caused by that misconduct. Moreover, as explained above, the threat of pri­vate litigation to enforce the securities laws helps to keep capital markets honest.

The market’s understanding that bad actors will be punished for their misdeeds translates to in­vestor confidence in the integrity of the market for public securities. Conversely, if the market understood that toothless mandatory arbitration provisions would allow public companies and their insiders to commit fraud with impunity, investors’ confidence in those companies—and the market in general—would be curtailed. Thus, refusing mandatory arbitration makes sense from management’s perspective as well. Why would investors want to invest in a company that was allowed to defraud them?

The market’s exploration of mandatory arbitration provi­sions is developing. Aside from Intuit, only one other Amer­ican company, Johnson & Johnson, has considered such a provision (also brought by Professor Scott). After Johnson & Johnson refused his attempt to include a mandatory arbi­tration shareholder proposal in the company’s proxy state­ment, Professor Scott sued. Pomerantz has been retained by the Colorado Public Employees’ Retirement Associa­tion to intervene in the Johnson & Johnson proxy litigation to ensure that investors’ rights are protected. Pomerantz Partners Marc I. Gross and Michael Grunfeld discussed this litigation in the May/June 2019 issue of the Monitor.

Even prior to intervening in the Johnson & Johnson proxy litigation, Pomerantz was no stranger to the fight against forced arbitration. When the SEC and U.S. Treasury de­partment signaled a potential policy shift toward forced arbitrations, Pomerantz took action. The Firm organized an international coalition of institutional investors to meet with SEC Chairman Jay Clayton and congressional staff, to caution against allowing forced arbitration/class action waiver bylaws. As a result of Pomerantz’s advocacy, ten Republican State Treasurers, in a letter co-authored by the State Financial Officers Foundation, urged the SEC to maintain their existing stance against forced arbitration. “It is a significant and unusual step to have ten Republican Treasurers publicly take a position contrary to two Repub­lican SEC Commissioners and the Treasury Department,” wrote partner Jennifer Pafiti in an article on the subject in the November/December 2018 issue of the Monitor. Look for updates on the fight against forced arbitration in future issues of the Monitor as the issue is analyzed by the courts.

Look for updates on the fight against forced arbitration in future issues of the Monitor as the issue is analyzed by the courts.

Delaware Rules on Books and Records

ATTORNEY: H. ADAM PRUSSIN | POMERANTZ MONITOR JANUARY/FEBRUARY 2020

In Lebanon County Employees’ Retirement Fund v. AmerisourceBergen Corp., investors recently won a significant victory in a case seeking access to defendants’ books and records under Section 220 of the Delaware Corporation Law. Section 220 allows stockholders to inspect corporate records if they have a “proper purpose” in seeking disclosure. One such proper purpose is established if they have a reasonable basis for suspecting wrongdoing by directors or management.

AmerisourceBergen is a distributor of pharmaceuticals, including opioid pain medications. It has been accused in a host of other lawsuits of recklessly distributing massive amounts of opioids to many so-called “rogue” pharmacies, amounts well in excess of any possible legitimate uses. These lawsuits include multi-district litigation brought by cities, counties, Indian tribes, union pension funds, and the attorneys general of virtually every state against distributors of opioids. Analysts have estimated that resolution of all these cases will likely result in payouts by the three main opioid distributors, including AmerisouceBergen, in the $100 billion range. It seems unsurprising, under these circumstances, that stockholders in the company would have a legitimate concern in determining whether directors or management did something wrong.

For decades the Delaware courts have been urging shareholders to use the “tools at hand,” inspection of corporate records under Section 220, to discover specific facts before commencing litigation against the company or its officers and directors. With those specific facts, stockholders who do decide to bring an action will be better able to plead claims with enough detail to survive the inevitable motion to dismiss.

In this case the investors’ demand for inspection stated that they sought to “investigate whether the Company’s Directors and Officers have committed mismanagement or breached their fiduciary duties” by failing to assure themselves that the company was avoiding suspiciously large sales to rogue pharmacies.

Given the magnitude and seriousness of the litigations that were already swirling around the company, one would have thought that it would be easy to show that the investors had a “reasonable basis” to infer that mismanagement or other breaches of fiduciary duty may have been committed. The court agreed, holding that “the wave of government investigations and lawsuits relating to AmerisourceBergen’s opioid-distribution practices is sufficient to establish a credible basis to suspect wrongdoing warranting further investigation.”

In recent years, some cases have upped the ante in requirements investors must meet to satisfy the “reasonable basis” burden. Notable was a Section 220 case brought by Pfizer stockholders, where the court seemed to agree that before they could look at any books and records, stockholders had to show that they already had evidence of actionable wrongdoing.

Vice Chancellor Laster, however, held that this is not the applicable standard on an action under Section 220. Noting that the “credible basis” standard is “the lowest possible burden of proof,” he held that it does not require that the investors prove that they already had enough facts and evidence to prevail on a specific breach of duty claim. If that were the standard, the investors would have no need to inspect the records. The court held that the reasonable basis standard was satisfied here because “there are legitimate issues of wrongdoing. … The stockholder need only establish by a preponderance of the evidence that there is a credible basis from which the court can infer a possibility of wrongdoing. A stockholder is not required to prove by a preponderance of the evidence that wrongdoing and mismanagement are actually occurring” or even that they are probably occurring. A plaintiff may meet the “credible basis” standard by making “a credible showing, through documents, logic, testimony or otherwise, that there are legitimate issues of wrongdoing.”

Since this was not a decision of the Delaware Supreme Court, we cannot say that this issue has been definitively resolved for all cases. But for now, it helps. A lot.

“Corporate Social Responsibility” and the Institutional Investor

ATTORNEY: JESSICA N. DELL | POMERANTZ MONITOR JANUARY/FEBRUARY 2020

In the last issue of the Monitor, Tamar Weinrib reported on the recent, surprising statement issued by the Business Roundtable (“BRT”), stating a new objective for corporations is to “ensure more inclusive prosperity” by encouraging companies to “build long term value by investing in their employees and communities.” Continuing a decades-long debate about “corporate social responsibility” (CSR), this statement was met with concern about accountability – not only because it would undermine the premise that corporations have responsibilities to shareholders above all, but because even for proponents of CSR there is a plethora of different codes and benchmarks and it is no small undertaking to achieve consensus about how to implement and measure such performance. It also puts an “ask” on investors, requiring closer oversight, including on index funds that may be less equipped or inclined to act as stewards.

Long before the BRT statement, “socially responsible investments” (SRI) and Environmental, Social and Governance (“ESG”) factors have been addressed by institutional investors aiming to factor these practices into their investment processes without compromising their risk– return objectives. Many, if not most, pension funds and asset managers take their stewardship responsibility seriously, fighting vigorously for shareholder rights and corporate governance reform. They often engage with companies before they invest, asking the tough questions.

Institutional investors may have less agency when investing in mutual funds. Morningstar recently published sobering news on the voting trends of the largest three index funds: Vanguard, Black Rock, and State Street Global Advisors (SSGA). In 2017, it had been much publicized that BlackRock and Vanguard voted to require Exxon Mobil to produce a report on climate change, so it was startling when Morningstar revealed that those two funds currently hold the worst voting records on social issues supported by other shareholders. In 2019, 84 resolutions addressing social factors received the support of more than 30% of shareholders, but BlackRock and Vanguard supported only 10% of these resolutions.

As Lucian Bebchuk of the Harvard Corporate Governance Project explains, the “agency-costs analysis shows that index fund managers have strong incentives to (i) underinvest in stewardship and (ii) defer excessively to the preferences and positions of corporate managers.” And he predicts that if the trend continues, the disparities will become more glaring as these big funds become more dominant.

Although recent reports show that too often investors as a whole, in exercising their proxy rights, vote blindly with management, there are also signs that investors are evolving to play a more meaningful stewardship role. Investors have made, and can continue to make, significant impacts through ESG investing. In follow-up research on its 2017 report, Professor Bebchuck’s Project revealed that ESG investing has grown to $30+ trillion, over a quarter of the world’s professionally managed assets.

The debate over CSR is a global one. Responsibility for the 2008 financial collapse has been placed, in large part, on failures in corporate governance. Over sixty codes around the world are focused on the issues inherent to CSR goals. But there has been far less focus on a uniform approach for the investment side. Only two such codes exist. The U.K. first issued governance guidance specifically for institutional investors with the Stewardship Code in 2010, and Japan followed in 2014 with Principles for Responsible Institutional Investors.

The Stewardship Code is set by the Financial Reporting counsel (FRC) an independent regulator in the UK and Ireland overseeing auditors, accountants and actuaries, and setting the U.K.’s Corporate Governance and Stewardship Codes which apply to “fi rms who manage assets on behalf of institutional shareholders such as pension funds, insurance companies, investment trusts and other collective investment vehicles.” The code, entirely voluntary, espouses seven principles:

• Institutional investors should publicly disclose their policy on how they will discharge their stewardship responsibilities.

• They should have a robust policy on managing conflicts of interest in relation to stewardship and this policy should be publicly disclosed.

• They should monitor their investee companies.

• They should establish clear guidelines on when and how they will escalate their activities as a method of protecting and enhancing shareholder value.

• They should be willing to act collectively with other investors where appropriate.

• They should have a clear policy on voting and disclosure of voting activity.

• They should report periodically on their stewardship and voting activities

In response to criticism that the Code did not go far enough, additional provisions took effect on January 1, 2020, setting a higher standard. A statement from Sir Jon Thompson CEO of the FRC said “Asset owners and beneficiaries will be able to see if those investing on their behalf are doing so in accordance with their needs and views … they will also be able to see the impact of their managers’ decisions, particularly in relation to environmental, social and governance issues, including climate change.”

From the outset, the Stewardship Code came with a “Comply or Explain” approach: if institutional investors do not comply with any of the principles set out, they may explain any meaningful difference and provide justification on their websites.

This is all food for thought. Vague pledges for corporate responsibility from BRT CEOs do little to lead the way for either corporations or institutional investors. Pomerantz, aware of the complexities of decision-making faced by institutional investors—such as when and how “responsible” investing makes economic sense—regularly organizes conferences and educational events to address these very issues. At such events, institutional investors from around the globe share their expertise and compare notes on developments in their countries. Our next Corporate Governance Roundtable, to take place in June, will focus on the latest developments in ESG investing and corporate governance.

Insider Trading: A Way Around The “Personal Benefit” Requirement?

ATTORNEY: LEIGH HANDELMAN SMOLLAR | POMERANTZ MONITOR JANUARY/FEBRUARY 2020

Because no statute specifically outlaws insider trading, the elements of the violation have been developed by the courts, most often in cases alleging violations of Section 10(b) of the Exchange Act.

Recently, disputes have arisen concerning whether someone providing insider information to another person must receive a personal benefit in exchange for the “tip” and, if so, what constitutes an impermissible personal benefit. As the Monitor previously reported, in 2015, the Ninth Circuit issued a controversial decision in U.S. v. Salman upholding the insider trading conviction of a defendant who had received inside information from a family member. The legal issue was whether the “personal benefit” requirement requires a financial quid pro quo, or whether conferring a “gift” on a personal friend or relative is enough. The Ninth Circuit held that an insider‘s intent to benefit his brother by tipping the information to him was sufficient to create a personal benefit for the tipper. Because the tipper’s motivation was improper, the tippee’s conviction was upheld.

This holding departed from the Second Circuit’s 2014 decision in U.S. v. Newman, which held that prosecutors must show that the tipper received a “tangible” benefit beyond the psychic benefit of helping a friend or family member. In declining to follow Newman, the Ninth Circuit held that Dirks v. SEC, a 1983 Supreme Court decision, allowed Salman’s jury to infer that the tipper breached a duty because he made “a gift of confidential information to a trading relative.’’

The split among the circuits paved the way for the Salman decision to be appealed to the Supreme Court. On December 6, 2016, the Court sided with the Ninth Circuit, holding that it properly applied Dirks to affirm Salman’s conviction. Under Dirks, the jury could infer that the tipper personally benefited from making a gift of confidential information to a trading relative.

The Supreme Court held ‘’when an insider makes a gift of confidential information to a trading relative or friend ... [t]he tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient.’’ In these situations, the tipper personally benefits because giving a gift of trading information to a trading relative is the same thing as trading by the tipper followed by a gift of the proceeds. The Court held that “[t]o the extent that the Second Circuit in Newman held that the tipper must also receive something of a pecuniary or similarly valuable nature in exchange for a gift to a trading relative, that rule is inconsistent with Dirks.”

Although the Court’s decision in Salman made it easier to prove insider trading, it did not eliminate the “personal benefit” requirement. More recently, the government has tried to circumvent this requirement entirely by criminally charging defendants under 18 U.S.C. § 1343 and § 1348, which criminalize wire and securities fraud, rather than under Section 10(b).

On December 30, 2019, in United States v. Blaszczak, the Second Circuit addressed for first time whether the government can criminally prosecute insider trading under Title 18 without proving personal benefit to the tipper. The Second Circuit upheld the convictions brought by the government under those provisions, finding that in such cases the government need not prove that the defendants received a “personal benefit” in exchange for the tip.

In Blaszczak, an employee of the Centers for Medicare and Medicaid Services (CMS) allegedly provided nonpublic information about prospective changes to certain Medicare reimbursement rules to his friend, Blaszczak (the tippee), who in turn provided the confidential information to analysts at his client, Management Company. Relying on this insider information, these analysts executed trades in health care companies that were affected by the rule change, realizing gains of over $7 million. The CMS tipper did not receive any money in exchange for the tip. The only “personal benefits” he received were free meals and tickets to sporting events, and an opportunity to work at the consulting firm where Blaszczak worked, which he ultimately turned down. The tipper and tippees were both charged with violating both 15 U.S.C. § 78j(b) of the Exchange Act (Section 10(b)) and with wire and securities fraud under 18 U.S.C. §§1343 and 1348.

The jury instructions for the Title 15 charge (violation of Section 10(b)) provided that the government had to prove that the tipper breached a duty by revealing material nonpublic information for a personal benefit, and that each tippee knew it. The court told the jury that personal benefit “need not be financial” and could be “the benefit one would obtain from simply making a gift … to a relative or friend.” However, in order to prove Title 18 charges, the government only had to prove that the defendants knowingly executed a scheme to defraud, which did not require personal benefit to the tipper or knowledge of that benefit by the tippee.

After a trial, the defendant was acquitted of the Exchange Act charges but convicted of the Title 18 charges. The verdict suggests that the government could not prove a personal benefit. In addition to not having to show a personal benefit to succeed on a Title 18 claim, the Court held that confidential government information may constitute “property,” the misappropriation of which can provide a basis for criminal liability under the Title 18 wire and securities fraud statutes.

The defendant appealed the jury verdict, mainly arguing that the government cannot use Title 18 wire and security fraud claims as a way around the doctrines the courts have developed for insider trading under Section 10(b) over the past forty years. Defendant argued that because Sections 1343 and 1348 contain the same operative fraud language as Section 10(b), the same elements that apply under the Exchange Act must apply under Title 18. Specifically, the defendant argued that the personal-benefit requirement should apply to Title 18 securities fraud. The majority of the Second Circuit panel rejected this argument, concluding that the personal-benefit requirement is inconsistent with Congress’s intent, through 18 U.S.C. § 1348, to provide the government with a broader mechanism for prosecuting securities fraud than that provided by Title 15.

The ruling in Blaszczak may alter the government’s future strategy for insider trading charges. The SEC’s enforcement jurisdiction is limited to civil charges under Title 15, in which case it must still prove a personal benefit consistent with Dirks. Accordingly, particularly in cases where a personal benefit on the part of the tipper is difficult to show, the DOJ may choose to bring prosecutions where the SEC declines, or the SEC may proceed under a different legal theory.

If the Blaszczak ruling is widely followed nationwide, it will change the landscape for insider trading liability, as the government can bring and win criminal claims under Section 18 while not being successful for civil claims under Title 15 for the same conduct. The government may bring criminal charges without bringing civil charges or may bring civil and criminal charges under different statutes with different proof.

Pomerantz Scores Critical Victory for Investors in Perrigo Company plc Litigation

ATTORNEY: JOSHUA B. SILVERMAN | POMERANTZ MONITOR JANUARY/FEBRUARY 2020

Pomerantz recently set important precedent for global investors. In the Perrigo securities litigation (Roofer’s Pension Fund v. Papa, et al.), Judge Arleo of the District of New Jersey certifi ed parallel classes of investors that purchased Perrigo shares in the United States on the New York Stock Exchange (“NYSE”) and in Israel on the Tel Aviv Stock Exchange (“TASE”). The ruling was the fi rst to certify a foreign purchaser class since the Supreme Court’s landmark 2010 ruling in Morrison v. National Australia Bank, Ltd.

Pomerantz Managing Partner, Jeremy Lieberman, commented, “We are very pleased with the district court’s decision granting class certification to both TASE and NYSE investors. We hope it paves the way for those investors that purchase on non-U.S. exchanges, particularly investors in dual-listed securities, to procure a recovery in the U.S. courts which would have otherwise been foreclosed by Morrison.”

Morrison appeared to close the door of U.S. federal courts to investors who purchased on foreign exchanges, reasoning that the Securities Exchange Act of 1934 was not intended to have extraterritorial effect. In that decision, the Supreme Court stated that “Section 10(b) [of the Exchange Act] reaches the use of a manipulative or deceptive device or contrivance only in connection with the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States.”

Morrison was particularly limiting for investors in dual-listed shares, a staple of most global portfolios. Dual-listed shares are traded both on U.S. and foreign exchanges, affording institutional investors the opportunity to execute trades on the venue offering the most favorable trading hours, pricing, and liquidity at any given moment. However, under Morrison, two purchasers of the same dual-listed stock at the same time injured by the same fraudulent misrepresentations and omissions might have very different remedies, depending on the trading venue. Those that purchased on a U.S. exchange would be able to join together with other similarly situated investors to collectively seek compensation in a U.S. class action. Investors purchasing on a foreign exchange, under Morrison, were generally left to pursue claims individually in a foreign court likely to be less familiar with and less favorable to securities fraud litigation.

The Perrigo action offered the perfect opportunity to test the bounds of Morrison. Perrigo is a global pharmaceutical company that has been dual-listed on the NYSE and the TASE for more than a decade. In connection with its dual-listing, Perrigo had elected to take advantage of a provision of the Israel Securities Act providing that its disclosure obligations in Israel would be governed by the standards of its country of primary listing – here, the United States – rather than by Israeli standards. Thus, for companies like Perrigo, Israeli law applies the standards of Section 10(b) of the Securities Exchange Act of 1934 to assess claims of securities fraud.

Perrigo violated Section 10(b) by making material misrepresentations and omissions that injured investors whether they purchased on the TASE or the NYSE. Specifically, to defeat a hostile tender offer and to artificially inflate its share price, Perrigo concealed problems with its largest acquisition, Omega, and anticompetitive pricing practices in its generic prescription drug business. While Perrigo’s misrepresentations and omissions helped convince shareholders to reject the tender offer, shares plummeted as the truth was disclosed.

In the litigation that followed, Pomerantz brought claims under Israeli law applying the Section 10(b) standard for TASE purchasers, as well as traditional claims under U.S. law for U.S. purchasers. In its opinion sustaining the core parts of the amended complaint over motions to dismiss, the Court held that supplemental jurisdiction was properly exercised over the TASE purchaser claims, noting that they applied the same standards as the claims asserted under U.S. law.

Class certification proved a larger battle. Pomerantz asked the Court to certify three classes: a U.S. purchaser class, a TASE purchaser class, and a tender offer class for investors who held Perrigo shares at the expiration of the failed tender offer. We bolstered arguments for certifying the TASE purchaser class with expert reports from a world-class econometrician, demonstrating that Perrigo shares traded efficiently on the TASE, just as they did on the NYSE, and from an Israeli law professor explaining the identity between the Section 10(b) cause of action incorporated under the Israel Securities Act for dual-listed companies, and under U.S. law. While defendants conceded that Perrigo shares traded efficiently in the United States, they vigorously disputed the efficiency of TASE trading. As a result, defendants argued, TASE purchasers were not entitled to a presumption of reliance and individual issues regarding reliance would defeat predominance, rendering class certification inappropriate.

However, Pomerantz and its expert marshalled evidence demonstrating that TASE trading satisfied each of the criteria traditionally used to assess market efficiency under Cammer v. Bloom: volume, analyst coverage, market makers, float and financial disclosure requirements relevant to Form S-3 eligibility, and cause-and-effect relationship between dissemination of value-relevant company-specific information and abnormal returns in stock prices.

The Court accepted these arguments, finding that “the majority of the Cammer factors … tip the balance in favor of finding market efficiency” and that the TASE purchaser class was therefore also “entitled to the Basic presumption of reliance.” As a result, the Court certified all three proposed classes. Defendants did not challenge certification of the TASE purchaser class in their petition for interlocutory appeal, which was limited to the tender offer class.

We expect other courts to follow Judge Arleo’s lead. Exercising supplemental jurisdiction of foreign securities claims while adjudicating U.S. claims does not offend Morrison and offers substantial efficiencies that benefit both plaintiffs and defendants. Litigating all claims in a single forum avoids duplicative discovery and motion practice, eliminates the risk of inconsistent judgments, and facilitates global settlement discussions.

Pomerantz Corporate Governance Roundtable

WITH SPECIAL GUEST SPEAKER PRESIDENT BILL CLINTON

Pomerantz, in association with The Corporate Governance Institute, Inc., is pleased to announce that on June 16, 2020 they will host a Corporate Governance Roundtable Event at the Waldorf Astoria Hotel in Beverly Hills, California with special guest speaker, President Bill Clinton.

The Roundtable will gather institutional investors to discuss their evolving role in managing the risk of governance and ESG challenges under the theme: The Collective Power to Make Change. This one-day event will combine the knowledge and experience of fiduciaries, legal counsel and governance professionals from around the globe with the opportunity to discuss important matters that affect the value of the funds they represent.

We are honored to announce the attendance of President Bill Clinton at this event. President Clinton served as the 42nd President of the United States and founder of the Clinton Foundation. During his time in office, President Clinton led the U.S. to the longest economic expansion in American history, including the creation of more than 22 million jobs. He was also the first Democratic president in six decades to be elected twice.

After leaving the White House, President Clinton established the William J. Clinton Foundation with the mission to improve global health, strengthen economies, promote healthier childhoods and protect the environment by fostering partnerships among governments, businesses, non-governmental organizations and private citizens to turn good intentions into measurable results. To recognize the voice, vision and counsel of President Clinton’s wife, Secretary Hillary Clinton, and their daughter, Chelsea, in shaping the William J. Clinton Foundation, in 2013 it was renamed the Bill, Hillary & Chelsea Clinton Foundation.

Today the Foundation has staff and volunteers around the world working to improve lives through several initiatives, including the Clinton Health Access Initiative, which is helping five million people living with HIV/AIDS to access life-saving drugs. The Clinton Climate Initiative, the Clinton Development Initiative and the Clinton Giustra Enterprise Partnership are applying a business-oriented approach to fight climate change worldwide and to promote sustainable economic growth in Africa and Latin America.

In the U.S., the Foundation is working to combat the alarming rise in childhood obesity and preventable disease through the Alliance for a Healthier Generation and the Clinton Health Matters Initiative. Established in 2005, the Clinton Global Initiative brings together global leaders to devise and implement innovative solutions to some of the world’s most pressing issues. So far, nearly 2,300 Clinton Global Initiative commitments have improved the lives of more than 400 million people in 180 nations.

In addition to his Foundation work, President Clinton joined with former President George H. W. Bush three times – after the 2004 tsunami in South Asia, Hurricane Katrina in 2005 and Hurricane Ike in 2008 – and with President George W. Bush in Haiti in the aftermath of the 2010 earthquake. Today, the Clinton Foundation supports economic growth, job creation and sustainability in Haiti.

Pomerantz and The Corporate Governance Institute, Inc. look forward to hearing President Clinton’s remarks as he shares his perspectives and experiences with the audience. Additional speakers, all specialists within their field, will address topics such as the latest governance developments, forced arbitration, ESG and governance developments in 2020 and board diversity.

At the conclusion of the educational portion of the day, guests are invited to attend a private dinner at the world renowned Greek restaurant, Avra, located in the heart of Beverly Hills.

Jennifer Pafiti, Partner and Head of Client Services at Pomerantz, has been involved in organizing a number of these Roundtable Events over the past few years, and comments: “These events bring together peers to discuss current issues that directly affect the asset value of the funds they represent. More importantly, though, this setting allows experts within their field to share ideas, opinions and best practices under an important theme, which this year is: The Collective Power to Make Change.” We look forward to welcoming you and President Bill Clinton on June 16, 2020 in Beverly Hills, California.

As seating is limited, kindly reserve your place by emailing: pomerantzroundtable2020@pomlaw.com. For additional questions, please contact Jennifer Pafiti at: jpafiti@pomlaw.com

The Supremes And Congress Ponder Disgorgement

ATTORNEY: CARA DAVID
POMERANTZ MONITOR NOVEMBER/DECEMBER 2019

The Kokesh Decision. The Supreme Court’s 2017 decision in Kokesh v. SEC held that SEC actions seeking disgorgement were subject to a five-year statute of limitations. However, the SEC—and investors—might find relief in recent bills now pending before Congress. On the other hand, there is a chance the SEC will lose its ability to seek disgorgement as an equitable remedy entirely unless the securities laws are amended.

With its decision in Kokesh, the Supreme Court left the SEC struggling to collect on long-running frauds. The disgorgement remedy is a powerful one—it forces defendants to cough up ill-gotten gains they obtained by violating the securities laws. While civil penalties are meant to function as both punishment and deterrent, disgorgement in theory functions under the premise that a wrongdoer should not be able to keep the ill-gotten gains from the fraud. In dollar terms, disgorgement awards often dwarf other remedies available to the SEC. The SEC never possessed explicit statutory authority to seek disgorgement, but federal district courts have been allowing them to do it for years on the premise that it was a form of “equitable relief.” The Kokesh decision held that disgorgement constituted a “penalty” for statute of limitations purposes and, therefore, was subject to the five-year statute of limitations that applied to civil fines or other statutory penalties. This prevented the SEC from recovering, according to agency estimates, more than $1.1 billion in proceeds, and hurt retail investors who could no longer hope to share in these disgorged funds.

Despite defense attorneys’ attempts to extend the Supreme Court’s reasoning to other forms of relief, Kokesh has almost universally been held to apply only to disgorgement. Even that has had a profound impact, however, not only by restricting the amount of money that could be recovered by the SEC when it brings a case, but as a deterrent to the SEC pursuing a case when the majority of ill-gotten gains will never be recouped. Indeed, in its year-end report, the SEC Office of the Investor Advocate itself raised “fewer investigations involving aged conduct” as one of the potential impacts of Kokesh. This has repercussions on private class actions, as SEC complaints often help plaintiffs in private actions.

“[A]s I look across the scope of our actions, including most notably Ponzi schemes and affinity frauds, I am troubled by the substantial amount of losses that we may not be able to recover for retail investors…,” SEC Chairman Jay Clayton stated on December 11, 2018 in testimony before the U.S. Senate Committee on Banking, Housing, and Urban Affairs. “Allowing clever fraudsters to keep their ill-gotten gains at the expense of our Main Street investors—particularly those with fewer savings and more to lose—is inconsistent with basic fairness and undermines the confidence that our capital markets are fair, efficient and provide Americans with opportunities for a better future.”

Congress Reacts to Kokesh. Investors and the SEC might be in for some help, though when that help will come, what it will look like, and to what degree it will benefit victims, are still up for debate. In March, Sen. John Kennedy (R-La.) partnered with Sen. Mark Warner (D-Va.) to introduce the Securities Fraud Enforcement and Investor Compensation Act, which would not overturn Kokesh but would grant the SEC more power than it currently has. Their bill would explicitly grant the SEC the authority to seek disgorgement, subject to the same five-year limitations period under Kokesh, but would also allow the SEC to seek restitution for an investor, in the amount of the loss that the investor sustained, subject to a ten-year statute of limitations. Unlike disgorged funds, whose disposition is subject to SEC discretion, restitution directly compensates the defrauded investors.

As that bill remains in committee, members of the House have progressed further. The Investor Protection and Capital Markets Fairness Act, proposed by Reps. Ben McAdams (D-Ut.) and Bill Huizenga (R-Mi.), passed the House Financial Services Committee in September by a bipartisan vote of 49-5. On November 18, it passed a full House vote by a margin of 314-95. This bill would give the SEC fourteen years to seek disgorgement of ill-gotten gains from fraudsters. McAdams’ original draft of the legislation had no statute of limitations, but the fourteen years was included as a compromise with those that believe the SEC should be restrained in their abilities. This bill has been referred to the Senate’s Committee on Banking, Housing, and Urban Affairs, on which both sponsors of the Senate bill sit.

SEC Chairman Clayton has expressed support for the Senate bill but has not publicly commented on the House bill. And many still oppose any extension of the five-year cutoff. For example, the Securities Industry and Financial Markets Association (SIFMA)–the leading trade association for broker-dealers, investment banks and asset managers operating in the U.S. and global capital markets–sent a letter to the House Financial Services Committee expressing its opposition to H.R. 4344. The letter, released to the public, read: “SIFMA strongly opposes increasing the limitations period of 5 years to 14 years, particularly where the SEC has historically used disgorgement to punish respondents, rather than recover monies for investors, as the Court found in Kokesh. The Court appropriately curtailed the SEC’s use of disgorgement to a 5-year limitations period in recognition of its historical overreach in wielding it against respondents.”

The issue SIFMA highlights is the same one that appears to have motivated the Supreme Court’s unanimous decision: the purpose of disgorgement. Though penalties and interest can be awarded to victims via a Fair Fund, there is something about disgorgement being premised in equity that almost compels the conclusion that it should be used to restore victims to where they were prior to the fraud. But that is often not how disgorged funds have been used. In the Kokesh decision, Justice Sotomayor, writing on behalf of a unanimous Court, noted that the disgorgement order in that case “bears all the hallmarks of a penalty: It is imposed as a consequence of violating a public law and it is intended to deter, not to compensate. … Disgorged profits are paid to the district courts, which have discretion to determine how the money will be distributed. They may distribute the funds to victims, but no statute commands them to do so. … True, disgorgement serves compensatory goals in some cases; however, we have emphasized the fact that sanctions frequently serve more than one purpose.” In this case, disgorgement, according to the Court, was a penalty because it served “retributive or deterrent purposes.”

Some commentators have queried whether Kokesh would have been decided differently if the disgorgement order in that case directed that the recovered funds be distributed entirely to defrauded investors.

Liu Raises the Stakes. The Supreme Court stated in a footnote in Kokesh that it was declining to take a position on “whether courts possess authority to order disgorgement in SEC enforcement proceedings or on whether courts have properly applied disgorgement principles in this context.” However, several of the justices questioned that authority during oral arguments.

Now they will get a chance to rule on it—on November 1, 2019, the Supreme Court agreed to hear the case Liu v. SEC, which squarely presents the issue of whether the SEC may seek and obtain disgorgement. In that case, the district court had ordered defendants to disgorge approximately $26.7 million and also imposed other monetary penalties. The court of appeals affirmed. The defendants petitioned the Supreme Court to take another look, arguing, among other things, that the treatment of disgorgement as an “equitable remedy” does not survive Kokesh. With Liu, the Supreme Court faces yet another case where the district court order does not specify that the disgorged funds will be returned to victims.

The race is on. With Congress not known for its speed, it’s likely the Supreme Court will rule before any bill becomes law. If it rules for petitioners, the SEC could lose its ability to impose disgorgement as an equitable remedy altogether until Congress acts.

Of note, both of the proposed bills would grant the SEC explicit authority to seek disgorgement, but neither of them requires that monies recovered go to victims. The Senate bill does get closer because the amendment currently in committee in the Senate includes “restitution” in addition to “disgorgement.” Under the restitution section, the SEC “may seek, and any Federal court, or, with respect to a proceeding instituted by the Commission, the Commission, may order restitution to an investor in the amount of the loss that the investor sustained as a result of a violation of that provision by a person that is—(A) registered as, or required to be registered as, a broker, dealer, investment adviser, municipal securities dealer, municipal advisor, or transfer agent; or (B) associated with or, as of the date on which the violation occurs, seeking to become associated with, an entity described in subparagraph (A).” This goes further than prior law but only covers a subdivision of fraudsters and, additionally, it does not mandate the SEC seek restitution. Under the bill, if the agency is proceeding after five years following the unjust enrichment, but before ten years, the agency would seek restitution because it could not seek disgorgement. That seems obvious but does not really get investors all the way there. Perhaps a better bill would require a certain amount of disgorged funds go to investors regardless of when the action is brought. Time will tell whether, as these bills proceed, amendments will alter them in accordance with the concerns the Supreme Court expressed in Kokesh and/or whether the opinion in Liu will alter the process.

Retiring Delaware Chief Justice Issues A Sweeping Manifesto For Corporate Law Reform

ATTORNEY: GUSTAVO F. BRUCKNER
POMERANTZ MONITOR NOVEMBER/DECEMBER 2019

It is not controversial to say that over the last two decades, no jurist has had a greater impact on the state of corporate governance in this country than Chief Justice Leo Strine of the Delaware Supreme Court. After all, Delaware is the state of incorporation for over 50% of all publicly traded corporations in the U.S. and 60% of Fortune 500 companies. Many other states, recognizing the preeminence of Delaware courts in the field of corporate law, have looked to Delaware court decisions for guidance on resolving open corporate law questions in their own jurisdictions. So Delaware court decisions on issues of corporate law have far-reaching ramifications. Chief Justice Strine has spent the last 21 years dispensing just such opinions, the first 16 on Delaware’s Court of Chancery, and since 2014, while leading the state’s highest and only appellate court. Earlier this year, Chief Justice Strine caused a bit of a stir when he announced that he would retire this fall.

Justice Strine’s decisions, bolstered by his vast academic output, have captivated and transformed corporate America. Many of his opinions are considered among the most influential rulings in corporate law. More often than not these decisions have protected corporate boards from investor challenges to their actions.

In 2013, Justice Strine, then Chancellor, set a new, more relaxed standard of review of investor suits challenging controller-led buyouts in the In re MFW Shareholders Litigation. Because the controlling shareholder is in a position to control the actions of the company, in the past such transactions have been reviewed by the courts under the “entire fairness” standard, which puts the burden on the controller to show that the transaction was fair. Chancellor Strine ruled that when a company sells to a controlling party, forcing out minority shareholders, the deal will be subject to a more relaxed business judgment standard of review as long as it is subject to two conditions: that it was negotiated and approved by a special committee of informed independent directors on behalf of the company; and that a majority of the non-controlling stockholders, being fully informed and uncoerced, vote to approve the deal. Virtually every controller-led buyout since then has contained those two conditions, thus making those deals almost impossible to challenge successfully. Most recently, the Chancery Court has extended the application of MFW to non-buyout related controlling party transactions.

Also in 2013, Chancellor Strine ruled in the Boilermakers Local 154 Ret. Fund v. Chevron Corporation case that Delaware companies can adopt forum selection bylaws that require that Delaware be the venue for deciding claims involving the internal affairs of the corporation. This decision further cemented Delaware’s exalted position as the center of corporate jurisprudence and helped limit multijurisdictional litigation.

In 2015, perched firmly as Chief Justice, Justice Strine upheld the lower court decision in Corwin et al. v. KKR Financial Holdings, holding that the more relaxed business judgment rule is the appropriate standard of review for a post-closing damages action when a merger not otherwise subject to the heightened entire fairness standard of review has been approved by a fully informed, uncoerced majority of the disinterested stockholders. Because MFW had put a chill on pre-closing challenges, most merger challenges were occurring post-closing. This ruling drastically cut back the number of post-closing challenges to corporate mergers and eased the threat of stockholder litigation as a potential cudgel for an improved sale price.

And in a string of appraisal action decisions culminating this past April in Verition Partners Master Fund Ltd. et al. v. Aruba Networks Inc., Chief Justice Strine all but eviscerated the practice of appraisal arbitrage litigation by finding that the negotiated deal price is the best starting point for determining true appraisal value. Appraisal arbitrage is the practice whereby activist investors buy up the shares of a corporation to be acquired by merger in order to assert appraisal rights challenging the price of the deal. The practice is controversial because the appraisal remedy was meant to protect existing stockholders forced to sell their shares in the merger, not financial opportunists who purchased shares at the last minute, hoping for an appraisal windfall.

So, after a career of setting important board protections, it was no small surprise that on the cusp of retirement, Justice Strine has now issued a sweeping proposal for overhauling American capitalism that suggests that corporate boards need to refocus their attention on worker rights.

Among the proposals laid out in his paper, titled “Toward Fair and Sustainable Capitalism,” Justice Strine posits that companies with annual sales over $1 billion should disclose annually how they treat workers and whether they operate in an ethical, sustainable, and environmentally responsible manner. He argues that accounting rules need to be amended so as to treat investments in human capital like other long-term investments and mandates disclosure on human capital investments.

Justice Strine also believes the tax system should be updated to reduce speculation, address climate change, and promote sustainable growth, innovation, and job creation. He would change the holding period for long-term capital gains from one year to five and would impose a modest tax on most financial transactions, transferring the tax revenue to a newly created Infrastructure, Innovation, and Human Capital Trust Fund.

Justice Strine would also prohibit a public company’s political spending without 75% of shareholders’ consent and would reform the union election process by permitting card check elections to make it easier for employees to join unions and collectively bargain over wages.

These proposals, often associated with the left side of the political spectrum, carry significant weight coming from such a prominent and respected jurist who spent much of his career defending corporate boards from exactly such prodding. Only time will tell if Justice Strine’s lasting legacy are the rulings from his seat on the bench or his admonitions as he steps down.  

The Newly Revised Role of A Corporation

ATTORNEY: TAMAR A. WEINRIB
POMERANTZ MONITOR NOVEMBER/DECEMBER 2019

The Business Roundtable, a lobbying group of CEOs formed to promote pro-business interests, recently issued a statement “modernizing its principles on the role of a corporation.” Upending the decades long, widely accepted view that the goal of a corporation is to increase shareholder value, nearly two hundred chief executive officers of some of the largest U.S. corporations recognized in that statement that investors are but one spoke on the wheel of a corporation’s success. Since 1978, the Roundtable had periodically issued “Principles of Corporate Governance” stating that the primary purpose of a corporation is serving its shareholders. Indeed, Milton Friedman, the University of Chicago economist who is the doctrine’s most revered figure, famously wrote in The New York Times in 1970 that “the social responsibility of business is to increase its profits.”

Now, 181 of the Roundtable’s 193 members, including Marry Barra of General Motors, Jeff Bezos of Amazon, and Tim Cook of Apple, have revised that stated purpose to “ensure more inclusive prosperity” by encouraging companies to “build long term value by investing in their employees and communities.” This includes new corporate ideals such as compensating employees fairly, providing adequate training and education, fostering diversity, dealing ethically with suppliers, and supporting communities. Both in its initial statement and a subsequent publication responding to questions and criticism, the Roundtable emphasized that the statement is not a “repudiation of shareholder interests in favor of political and social goals.”

The primacy of shareholder interests was solidified in the 1980s, in an era of hostile corporate takeovers. In many of those cases, boards of directors, seeking to protect their positions, justified their rejection of buyout offers that looked favorable to shareholders by hiding behind other interests, such as protecting employees from post-takeover layoffs. In a series of landmark decisions, the Delaware courts enshrined the notion that once a company is for sale, “maximizing shareholder value” has to be the most important consideration.

In addition to other pro-corporation endeavors, in 1975 the Roundtable helped defeat anti-trust legislation; in 1977 it helped defeat a plan for a consumer protection agency and successfully blocked labor law reform; and in 1985 it successfully lobbied for a reduction in corporate taxes. The current shift in corporate purpose acknowledges the integral role large corporations need to play in effectuating change on issues like climate change and water and resource scarcity. The timing of this acknowledgment is not accidental. Large corporations have increasingly come under attack for their failures to protect societal interest—including health, environment, and consumer privacy—while chasing profits. For example, a judge recently fined Johnson & Johnson $572 million for contributing to the opioid crisis in Oklahoma. ExxonMobil has been criticized for the years it spent challenging climate science and slowing global action. Facebook has been heavily criticized for sharing its users’ data with other companies without consent.

 While laudable in theory, the Roundtable’s new corporate purpose statement is wholly devoid of actionable content. Words, however lofty, are insignificant without concrete change. Critics worry that the statement promotes managerial confusion as to how to balance and prioritize goals that are at times conflicting—employees versus community versus stakeholder value. Indeed, the Council of Institutional Investors responded to the Roundtable’s statement by declaring that “accountability to everyone means accountability to no one.” Moreover, instituting new policies to effectuate the new corporate purpose would mean overhauling entire business models for some businesses— rendering it unlikely such corporations would practice what they’ve just begun to preach. In addition, notably missing from the Roundtable’s statement is any mention of other major corporate issues such as exorbitant executive compensation, which dwarfs median employee pay by many multiples. Treasury Secretary Steve Mnuchin has declared, “I wouldn’t have signed it,” calling the statement a “simple answer” that “does not fully explore the issues.” Another vocal critic stated, “how can you tell people who had confidence in you and devoted their hard-earned money to you that they are last in line?”

Interestingly, Chief Financial Officers do not seem to share their CEOs’ view that change is necessary. In a CNBC CFO survey, almost 100% of CFOs rated their companies at least “above average” in delivering value to customers, investing in their employees, supporting communities and dealing with suppliers.” 96% also rated their companies “above average” in delivering long-term value to shareholders.

Pomerantz Strategic Consumer Practice Targets The Auto Industry

ATTORNEYS: BY JORDAN L. LURIE AND ARI Y. BASSER
POMERANTZ MONITOR NOVEMBER/DECEMBER 2019

Pomerantz is proud to introduce its Strategic Consumer Litigation Practice, headed by Jordan Lurie, a partner in the Firm’s Los Angeles office. This practice group represents consumers in actions that recover monetary and injunctive relief on behalf of class members while also advocating for important consumer rights.

Forget the engine and the shiny rims. Connected vehicles have become the next big thing for the automotive industry.

Nothing is driving the acquisition of car data faster than, well, driving. While connecting cars to computers is not new, what has changed is the volume and precision of the data and the information that is being extracted and connected to the Internet. The average modern-day car can contain 100 million lines of code (more than a space shuttle). Connected vehicles can monitor, collect and transmit information about their external and internal environment. The types of data generated by modern vehicles include sensitive categories such as location, biometric and behavioral information. Car makers have transformed the automobile from a machine that helps us travel to a sophisticated smartphone on wheels.

Bundling and selling data from connected cars will be a massive new revenue stream for auto manufacturers on the order of billions of dollars a year. Car manufacturers also are profiting from car data by building partnerships with third party service suppliers and exchanging data with them. If a pizzeria that a driver frequents is provided with data about the driver’s location as she’s driving by, the driver will get an offer to get a discount on a pizza if she picks it up right then and there, hot and ready to go. This is possible because of the vehicle data the car manufacturer has provided, and companies such as pizzerias are willing to pay car manufacturers for that data. According to a study by McKinsey & Company, by 2020 – just around the corner – automakers will be able to make more money selling vehicle data than by selling the cars themselves, and by 2030, the market for in-vehicle connectivity worldwide is expected to reach $750 billion.

In their desire to monetize vehicle data, car makers have turned on a powerful spigot of precious personal information without adequate disclosures and without offering to compensate drivers for use of their own car data. Consumers deserve, and are legally entitled, to know what data their car is collecting and transmitting and who has access to this information, and to have the opportunity to opt-in to data collection and the ability to participate in the commercialization of their own data. Car manufacturers are not entitled to use it for free and without full and adequate disclosures at the point of sale.

To address these wrongs on behalf of drivers and consumers, Pomerantz has instituted a series of actions against major car manufacturers, including General Motors and Jaguar Land Rover, to compel defendants to establish a framework for compensating drivers for defendants’ use of their car data and/or to compensate current and future car owners for the use of their car data (for example, by offering buyers financial incentives for the collection and use of vehicle data, lower monthly lease payments or discounted pricing or rebates, direct free features or services, or by otherwise subsidizing the cost of the car).

Pomerantz also seeks to require all car companies to provide prospective owners with written vehicle data and disclosure policies at the time of sale or lease and to obtain adequate consent or authorization to use or take information or data from owners’ car computer systems prior to purchase. At a minimum, there should be an easy-to-read facts sheet that provides for, among other things, opt-in consent to data collection and use; it should be possible for vehicle owners to access their data at any time in a usable format, delete their data at any time, revise the parameters of their data sharing at any time, and turn off their data at any time; and any data collected should not be monetized or utilized without the vehicle owners’ express consent. Absent any express agreement by vehicle purchasers, car companies should limit data collection to information reasonably necessary to operate the vehicle and maintain vehicle safety (including enabling real time emergency calls, immediate information that facilitates rescue services and road hazard warnings).  

Vehicle Emissions Warranty Fraud Drives New Wave of Litigation

Owning a vehicle is one of the largest expenditures of households in the United States, second only to housing. According to the American Automobile Association, an average repair bill is between $500 and $600, which an estimated 64 million American drivers (33% of vehicle owners) would not be able to pay without going into debt. To offset the soaring price of vehicle ownership and maintenance, most new vehicles come with a factory written warranty which is a promise, made by a manufacturer, to stand behind its product and to fix certain defects or malfunctions up to a certain time period or mileage milestone (whichever comes first). The manufacturer’s warranty covers all major components of a vehicle and is intended to pay for any covered repairs or part replacements during the warranty period. For decades, car manufacturers have been selling vehicles that are subject to unique state regulations regarding emissions standards. California’s stringent emissions rules require automakers to provide longer warranties and cover more items in order to identify malfunctioning emission control components and encourage repair to ensure emission control systems continue to function as designed and emissions remain low. Under California law (and similar regulations in other states), vehicle manufacturers are required to identify all “high-priced warranted parts” in Partial Zero Emissions Vehicles (“PZEVs”) and hybrid vehicles, which are entitled to warranty protection for 7 years or 70,000 miles under California’s High-Cost Emissions-Related Parts Warranty. California emissions warranty laws supersede and extend any manufacturer’s warranty offered at the point of sale. A “high-priced warranted part” is a warranted part which is a component that “affects any regulated emission from a motor vehicle or engine which is subject to California emission standards,” or that causes a vehicle’s on-board diagnostic malfunction indicator light to illuminate. Automotive companies determine whether the “individual replacement cost” of a warranted part exceeds the applicable cost limit by taking into account the model year of the new vehicle at issue and the annual average nationwide urban consumer price index published by the United States Bureau of Labor Statistics (“CPI”). The relevant time period for this determination is the time of certification. The “replacement cost” of an individual component is equal to “the retail cost to a vehicle owner” and includes “the cost of the part, labor, and standard diagnosis.” For each new vehicle, the manufacturer has the duty to identify, with supporting background information, each of the emissions related and high-priced parts that are entitled to extended warranty coverage as a high-price emissions part. Pomerantz has uncovered the fact that car manufacturers unilaterally identify some, but not all, of the “high-priced” warranted parts that should properly be covered under the emissions warranty for 7 years and 70,000 miles in order to minimize the manufacturers’ warranty exposure. By not comprehensively identifying, in their warranty booklets and in information provided to dealerships, all of the parts that should be included as “high-priced” warranted parts, car manufacturers are able to limit the warranty coverage for those parts to only 3 years and 50,000 miles. As a result, consumers are forced to pay out of pocket for these repairs which, by operation of law, should be paid for by the manufacturers. To date, Pomerantz has initiated actions in state and federal courts against BMW, Jaguar Land Rover North America, Kia, and Hyundai, to recover reimbursement of all costs wrongfully incurred by vehicle owners for repairs that should have been covered under California’s high-cost emissions warranty law, and to obtain orders compelling these manufacturers to accurately and comprehensively identify all parts and labor that should be covered under California’s high-cost emissions warranty. These actions will allocate repair costs appropriately between manufacturers and vehicle owners and promote California’s interest in curbing emissions. 

The SEC’s Recent Approach To Cryptocurrency

ATTORNEY: VILLI SHTEYN
POMERANTZ MONITOR SEPTEMBER/OCTOBER 2019

At first glance, the U.S. Securities and Exchange Com­mission (the “SEC”) has had a reserved and seemingly inconsistent approach to cryptocurrency, at times stepping into the fray for enforcement actions against a particular cryptocurrency it deems a security, but often staying out of the picture and refusing to provide detailed guidance. Although this leaves much to be desired, with many open questions about how defrauded prospective plaintiffs could proceed themselves, the few decisions the SEC has made reveal a lot.  

The Threshold Question: Is it a Security?  

Despite many commentators describing an uncertain ap­proach, the SEC has given a fairly clear test for when it will treat cryptocurrencies as securities and subject them to the onerous rules that come with the classification. Important­ly, on June 4th, 2019, the SEC sued Kik Interactive, Inc. in relation to its sale of the digital token Kin without regis­tration. The SEC claimed it was a security because Kik’s marketing presented it as an investment that would reap profits from Kik’s efforts, and met the traditional Howey test for investment contracts. The SEC treated another Initial Coin Offering (“ICO”) very differently. In the earlier case of Turnkey Jet, Inc.’s ICO of TKJ digital coins, the SEC issued its first no-action letter in this sphere on April 3, 2019. It deemed TKJ not a security, because the marketing did not hold it out as an investment opportunity with an expecta­tion of profits from the company’s efforts to develop the digital infrastructure around the coin. The key component was that the coin was to be used only for buying charters, and the digital platform was already established, rather than part of an ongoing project that coin purchasers were buying themselves into to reap potential profits if and when it was successful, in contrast to Kik and their ICO of Kin. This clearly shows how TKJ was more like a currency, to be used for its function, while Kin was an investment se­curity, and not being sold or purchased for its utility as a digital currency. Kik made statements about how its coin would increase in value due to its efforts to further develop the platform, while TKJ cautiously crafted its marketing to not take on any characteristics of a security.  

These two examples offer guidance to prospective of­ferors of ICOs on how to avoid securities treatment, and importantly, to prospective class action securities plaintiffs attempting to convince courts that a digital coin at the heart of their suit is a security.  

To recover for securities fraud when a cryptocurrency is involved, the threshold question will always be whether the digital tokens or coins are a security in the first place. The SEC guidance, the “Framework for ‘Investment Contract’ Analysis of Digital Assets,” provides a host of factors for whether a cryptocurrency will be regulated as a security. With the Howey test as a background, The SEC defines these factors to include: purchasers’ expectation of profit from the efforts of the issuer of the coin; whether a mar­ket is being made for the coin; whether the issuer is ex­ercising centralized control over the network on which the coins are to be traded; the extent of the development of the blockchain ledger network, whether the coins are to be held simply for speculation or are to be put to a specific use; prospects for appreciation, and use as currency. This undergirds an important dichotomy that has emerged be­tween the Existing Platform and the Developing Platform. If a cryptocurrency has a blockchain distributed ledger platform already created before money is raised through an ICO, and is run by a distributed network, then it is not likely to be defined as a security, whereas if the platform is still under development and under the management of the issuer at the time the coins are offered to the public, and is created and/or developed with the money raised in the ICO, which boosts the value afterwards, it is likely to be defined as an investment security.  

Investors and the Role of Class Actions  

Given the lucrative growth, volatility, and sometimes rapid declines we have seen in cryptocurrency values over the past few years, many have treated cryptocurrency as an investment, and many have suffered great losses. Crypto­currencies, even if not on public stock exchanges, are trad­ed with the same ease and appeal to unsophisticated retail investors as stock for Apple and Walmart. They are readily available on Coinbase, Binance, and other popular web­sites and apps, and a host of individuals and companies have begun releasing their own peculiar coins. Importantly, the novelty and ease of access to retail investors makes the cryptocurrency world one ripe for deceit and fraud, especially for the multitude of very volatile coins that are treated the same as securities by purchasers. As an illus­tration, users on Coinbase follow a chart with daily, weekly, monthly, and yearly curves showing the price movements of various digital currencies, and many treat it no differently than they would their E-trade account. Thus, this is a situ­ation where securities class actions should take on a big role, as they are often the chief vehicles to defend the kind of diffuse harm to ordinary investors that is likely to take place with these digital coins.  

Furthermore, due to the exponential growth of money held in cryptocurrencies, institutional investors are also follow­ing suit and adding them to their portfolios. According to a study released by Fidelity Investments, around half of institutional investors believe digital assets are appropriate for their portfolios.  

In Balestra v. ATBCOIN, the proposed plaintiff class sur­vived dismissal on the threshold question. The Judge found all the elements of a security met on the facts as alleged, finding that the ICO intended to raise capital to create the blockchain, and that efforts to do so by ATB would increase the value of the investment if successful. In the case of Rensel v. Centra Tech, purchasers of coins in a $32 million ICO are attempting to certify a class in their securities fraud suit. The company is already facing crim­inal and SEC enforcement actions for its allegedly false and misleading statements about licensing agreements it claimed to have with major credit card companies, and other alleged falsehoods. One of the main points that the proposed class focus on in their motion is whether the CTR tokens are investment contract securities, and they are trying to use the Howey test to make arguments sim­ilar to those used by the SEC against KIK: that investors in CTR invested money in the coin with an expectation of profits, there was a common enterprise with no investor control over the coin’s value, and the value was tied to the managerial efforts by Centra Tech and its executives. This threshold question will make or break the case, and whatever the court decides could set important early-stage precedent in this sparsely populated cryptocurrency sub-class of securities class actions. There are also class ac­tions pending against Ripple and Tezos.  

Facebook has recently announced their own new cryp­tocurrency: Libra. The statements the company released about Libra seem to take the prior SEC actions into con­sideration, such as presenting it as a currency with a stable value backed by deposits and low-risk government secu­rities, rather than an investment vehicle. A potential issue stems from an audience Facebook has explicitly stated they will target, namely, those who do not use traditional banks. These individuals are the least sophisticated in financial matters, and the most vulnerable to fraud. While Facebook and others may state that their coins are cur­rencies, they must be monitored diligently to ensure users, especially the most vulnerable, are not purchasing them as an unprotected substitute for the stock market. Securities class actions will be a viable means of protecting such individuals if things go sour with Libra or the many other ICOs already present or likely to hit the market soon.

Facebook Settles With U.S. Agencies

ATTORNEY: MARC C. GORRIE
POMERANTZ MONITOR SEPTEMBER/OCTOBER 2019

In a press release issued July 24, 2019, the Securities and Exchange Commission announced charges against Facebook, Inc. as well as the settlement of the case; Facebook has agreed to pay $100 million to settle the SEC charges. This comes on the heels of Facebook’s settlement with the Federal Trade Commission (“FTC”), which provided for a record fine of approximately $5 billion arising from the same privacy violations.  

In 2012, the FTC charged Facebook with eight violations regarding privacy concerns, including making misleading or false claims regarding the company’s control of the personal data of their users. The FTC alleged that Face­book had inadequately disclosed its privacy settings that control the release of personal data to third party develop­ers, particularly in instances where one user designated its personal information as private, yet that information was still accessible via a friend who had not so designated it. This, the FTC alleged, dishonored users’ privacy choices; the company settled those 2012 charges by agreeing to an order prohibiting Facebook from making misrepresen­tations regarding the privacy and security of user data and requiring the establishment of a privacy program.  

One of the central allegations of the FTC complaint was that while Facebook announced it was no longer allowing third parties to collect users’ personal data, it continued to allow such collection to continue. Further, the FTC al­leged that Facebook had no screening process for the third parties that received this data.  

The SEC alleged that Facebook knowing misled investors regarding their treatment of purportedly confidential user data for over two years. While the company publicly stated their users’ data “may be improperly accessed, used or disclosed,” Facebook actually knew that a third-party de­veloper had done so. Merely identifying and disclosing potential risks to a company’s business rings hollow when those risk materialize and no disclosure is made.  

According to the SEC’s complaint, Facebook discovered in 2015 that user data for approximately 30 million Americans was collected and misused in connection with political ad­vertising activities. The complaint alleges that Cambridge Analytica, a data analytics company, paid an academic researcher to collect and transfer Facebook data to cre­ate personality profiles for American users, in violation of Facebook’s policy that prohibits developers, including researchers, from selling or transferring its users’ data. The data gathered and transferred to Cambridge Analytica included names, genders, birthdays, and locations, among other pieces of information. This discovery was confirmed to Facebook by those involved in 2016.  

It was during this period that Cambridge Analytica was hired by the Trump campaign to provide data analysis on the American electorate. Touting its cache of some 5,000 data points and personality profiles on every American, Cambridge Analytica assisted the campaign in identifying “persuadable” voters, though it maintains that this anal­ysis was done using data maintained by the Republican National Committee, not by Cambridge Analytica.  Until Facebook disclosed the incident in March of 2018, it continued to mislead investors in SEC filings and through news sources by depicting the risk of privacy violations as merely possible, although they had actually occurred, and by stating that it had found no evidence of wrongdoing, even though it had.  

Compounding the company’s shortcomings was the SEC’s contention that Facebook had “no specific policies or procedures in place to assess the results of their investigation for the purposes of making accurate disclosures in Facebook’s public filings.” Had Facebook had such mechanisms in place, the presentation of user data mis­use as a hypothetical risk, when in reality it had occurred, would have been prevented.  

The resolution of this enforcement action by the SEC continues the strong message the agency has been sending regarding the accuracy of public companies’ risk disclosures concerning data privacy and cyber security. This portends to be merely an early round in Facebook’s struggles to bring its business practices under control.

Delaware Supreme Court Grants Investor Request To Inspect Electronic Corporate Record

ATTORNEY: SAMUEL ADAMS
POMERANTZ MONITOR SEPTEMBER/OCTOBER 2019

A recent decision by the Delaware Supreme Court clar­ified that shareholders are potentially entitled to receive emails, text messages, and other electronic records in connection with well-founded books and records requests under certain circumstances. Previously there had been some doubt that produceable “books and records” included those stored in electronic form, with courts often limiting production to hard copy documents actually reviewed by the board. In most cases, traditional, non-electronic documents will likely be sufficient to satisfy a plaintiff’s proper purpose in a books and records action.  

By way of background, many states, including Delaware, allow shareholders to request access to review corporate books and records provided, in general, that the share­holder can articulate a “proper purpose” and that the documents sought are narrowly-tailored and reasonably related to the shareholder’s proper purpose. A share­holder may inspect a corporation’s books and records for any proper purpose rationally related to the stockholder’s “interest as a stockholder.” Commonly accepted proper purposes include valuing a shareholder’s interest in a company and investigating wrongdoing, mismanagement or corporate waste. Shareholders also commonly request books and records in anticipation of serving a litigation demand on a public company.  

A books and records request can be a vital tool for share­holders weighing whether to file a potential shareholder lawsuit. Documents produced in response to a books and records demand can be instrumental in providing addition­al evidence that allows a plaintiff to prevail on a motion to dismiss, by presenting detailed and specific information detailing the alleged wrongdoing and demonstrating that the directors participated in or known about the wrong-doing or otherwise have a conflict of interest. In recent years shareholder plaintiffs have increasingly made use of books and records demands prior to commencing litigation. In particular, the Delaware courts have admon­ished shareholders to use the “tools at hand” and request access to critical books and records prior to commencing certain types of shareholder lawsuits, including share-holder derivative actions and lawsuits challenging mergers and acquisitions.  

In KT4 Partners LLC v. Palantir Techs., Inc., the Delaware Supreme Court reversed a lower court’s decision deny­ing a request for access to certain electronic books and records. The plaintiff’s books and records demand sought to “investigate fraud, mismanagement, abuse, and breach of fiduciary duty” by officers and directors of Palantir. Although the trial court found that the plaintiff had shown a proper purpose, it nonetheless denied the plaintiff’s requests for the production of emails and other electronic documents related to that proper purpose.  

On appeal, the Delaware Supreme Court determined that the Court of Chancery had abused its discretion by “denying wholesale [plaintiff’s] request to inspect emails” related to its proper purpose. In this instance, the plaintiff was able to identify documents that it needed and provided a basis for the court to infer that those documents likely existed in electronic form. The Delaware Supreme Court concluded that Palantir “did not honor traditional corporate formalities … and had acted through email in connection with the same alleged wrongdoing that [plaintiff] was seeking to investigate.” Making matters worse, Palantir, faced with plaintiff’s allegations, failed to present any evidence of its own that more traditional materials, such as board resolutions or minutes, even existed, much less would satisfy plaintiff’s need to investigate its proper purpose. Thus, the court took the unusual step of order­ing the production of emails in addition to more traditional corporate books and records.  

A clear takeaway from the court’s decision is that, if a company elects to conduct business through electronic communications, it assumes the risk that these electronic communications may be the subject of a books and records demand. To this end, the court noted that a company “cannot use its own choice of medium to keep stock-holders in the dark about the substantive information to which [the Delaware books and records statute] entitles them.” Conversely, where a company is careful to conduct all of its official business through more traditional channels, a plaintiff will likely have more difficulty demon­strating its need to access electronic commu­nications and electronic documents in a books and records action.  

Following the reasoning of the KT4 decision, the Delaware Chancery Court recently ordered the production of electronic communication in a books and records action against Facebook involving data privacy breaches. Among other categories of documents, the plaintiffs in that action sought “electronic communications, if coming from, directed to or copied to a member of the Board,” regarding the alleged misconduct. There, the court found that “[p]laintiffs have presented evidence that [Facebook] Board members were not saving their [hardcopy] communica­tions regarding data privacy issues for the boardroom.” Limiting its production to hard copy documents, Facebook produced only a compilation of highly redacted Board minutes that contain “essentially no information regarding the relevant subject.” Accordingly, the court in that instance granted in part plaintiffs’ request to produce electronic communications, even though Facebook ad-hered to many “traditional corporate formalities” which Palantir did not.  

Read together, KT4 and Facebook indicate that Delaware courts are beginning to take a more contemporary, real world approach in considering whether the production of electronic communications are necessary to satisfy a plaintiff’s proper purpose in a books and records actions. Where plaintiffs are able to present evidence that a compa­ny utilizes electronic communications in conducting official business, they will be able to present stronger arguments in favor of the production of electronic communications in books and records actions and, in the process, potentially secure the production of evidence which may, in turn, be critical in building a case at the early stages of litigation. Given the crucial role played by electronic communications in most business transactions, it is likely that production of such documents will be far more commonplace in future books and records cases.

Second Circuit Again Considers “Price Maintenance Theory” In Securities Class Actions

ATTORNEY: BRIAN CALANDRA
POMERANTZ MONITOR SEPTEMBER/OCTOBER 2019

On June 26, 2019, the Second Circuit heard oral argument on the defendants’ appeal of the district court’s class certification order in Arkansas Teacher Retirement System v. Goldman Sachs Group, Inc. (“ATRS”). The panel’s decision could provide guidance on how district courts should apply the Supreme Court’s decision concerning the “fraud on the market” presumption of reliance in securities fraud class actions involving the so-called price maintenance theory. This theory asserts that defendants’ fraud did not inflate the price of the company’s stock but, rather, prevented it from falling by misrepresenting or concealing bad news.  

Demonstrating that the critical issue of investor reliance can be established on a class wide basis has always been a crucial issue in securities litigation. In Basic v. Levinson, the Supreme Court held that in securities class actions involving stock traded on “efficient markets”, courts may presume that investors all relied on “the integrity of the price set by the market,” and that fraudulent statements would have distorted the market price. In Halliburton Co. v. Erica P. John Fund, Inc. (“Halliburton II”), the Supreme Court held that defendants can rebut the presumption by showing “that the asserted misrepresentation (or its correction) “did not affect the market price of the defendant’s stock” because it was not “reflected in the market price at the time of [the investor’s] transaction.”  

The simplest and most straightforward evidence of price impact is a misstatement quickly followed by an increase in the market price. Sometimes, however, plaintiffs try to demonstrate price impact by showing that the statement in question “maintain[ed] the inflation that is already present in a security’s price.” In other words, under this “price maintenance” theory, price impact is shown where a mis­statement maintains that security’s artificially inflated price.  

The Supreme Court’s decision in Halliburton II did not address several issues concerning the fraud-on-the-market presumption, including how defendants can rebut plaintiffs’ showing of price impact in cases alleging price maintenance. The Second Circuit panel in ATRS, however, squarely raises these issues.  

ATRS arose out of losses incurred by investors in four collateralized debt obligations issued by Goldman Sachs (the “Goldman CDOs”). The Goldman CDOs in 2006 and 2007, shortly before the 2008 financial crisis, without disclosing that the CDOs were designed so that a Goldman hedge fund client, or Goldman itself, could reap billions in profits when the assets underlying the CDOs failed.  

Plaintiffs, purchasers of Goldman common stock, filed a class action against Goldman and certain of its officers and directors alleging that they had made material misstatements and omissions regarding the conflicts of interest attendant to the Goldman CDOs, which harmed investors in Goldman’s stock when the stock price declined after the conflicts of interest were disclosed. According to plaintiffs, while Goldman was marketing the CDOs to its clients, it was filing 10-Ks with the SEC and releasing annual reports assuring investors that the firm had “ex­tensive procedures and controls that are designed to identify and address conflicts of interest.” Plaintiffs alleged that these and other statements were revealed to be false when the press reported that (i) the SEC had filed a civil lawsuit charging Goldman with securities fraud in connection with one CDO, (ii) the United States Department of Justice had opened a criminal investigation into whether Goldman had committed secu­rities fraud in connection with its mortgage trading and (iii) the SEC had opened an investigation into a second CDO.  

After the court rejected defendants’ motion to dismiss the complaint, the ATRS plaintiffs then moved to certify a class of all purchasers of Goldman common stock during the relevant period. Defendants opposed class certification on the grounds that plaintiffs had failed to demonstrate “price impact.” Specifically, defendants submitted declara­tions and affidavits saying that Goldman’s stock did not increase on the dates that the 10-Ks and annual reports containing the alleged misrepresentations were dissem­inated, nor had the price of Goldman’s stock decreased on 34 days before 2010 when the press had previously reported the conflicts of interest concerning the Goldman CDOs. Goldman’s stock did, however, decline significantly after the disclosures that the government was investigating and suing Goldman over its role in issuing and underwrit­ing these CDOs.  

The district court rejected defendants’ arguments and cer­tified the class, holding that defendants had not provided “conclusive evidence that no link exists between the price decline [of Goldman stock] and the misrepresentation[s]” (emphasis added). Among other things, the Court held that it could not consider defendants’ arguments that Gold­man’s stock price had not increased on the dates of the alleged misstatements or decreased on dates of press reports regarding Goldman’s alleged conflicts of interest in connection with the Goldman CDOs because, the court said, “truth on the market” and materiality defenses were not appropriate to consider at the class certification stage.  

While defendants’ appeal to the Second Circuit was pending, a different Second Circuit panel ruled in Waggoner v. Barclays plc (“Barclays”), where the investor class was represented by Pomerantz LLP. The Barclays panel held that when opposing a motion to certify a class in a securities fraud action, a defendant can rebut a purported showing of price impact by demonstrating by a preponderance of the evidence that an alleged misrepresentation had no effect on the price of the security at issue. While Barclays was a significant victory for investors, the “preponderance of the evidence” burden it seemed to be placing on de­fendants to rebut price impact was less onerous than the “conclusive evidence” required by the district court in the ATRS case.  

Citing Barclays, the Second Circuit reversed the district court’s certification of the ATRS class because it was unclear whether the district court had applied Barclays’ “preponderance of the evidence” standard. On remand, the ATRS Plaintiffs relied on a declaration and testimony from an expert who concluded that the declines in Goldman’s share price after disclosure of the government’s actions against Goldman were at least in part attributable to the revelation that defendants had made misstatements con­cerning Goldman’s conflicts of interest, commitment to its clients and compliance with governing laws Defendants countered with expert reports and testimony that purport­ed to show that the alleged misrepresentations had no effect on Goldman’s stock price because plaintiffs’ expert testimony was unreliable and incomplete, and Goldman’s stock price did not decline on 36 different days prior to 2010 when the press published articles concerning alleged conflicts of interest with regard to the Goldman CDOs.  

The district court rejected defendants’ arguments and re-certified the class. The court first held that plaintiffs’ expert had established a link between the reports of Goldman’s conflicts and the subsequent declines in Goldman’s share price. It then held that defendants’ evidence that Goldman’s stock price had not declined on 36 days prior to 2010 did not rebut plaintiffs’ showing because “[t]he absence of price movement . . . in and of itself, is not sufficient to sever the link between the first corrective disclosure and the sub­sequent stock price drop.” Finally, the district court held that defendants’ arguments that the alleged misstatements could not have affected Goldman’s stock price because those statements were immaterial was not appropriate to consider at the class certification stage.  

Defendants appealed again, arguing, among other things, that the district court had erred in applying price mainte­nance theory. They argued once again that there was no evidence that Goldman’s stock price was ever “inflated” by defendants’ alleged fraud, and that the district court had never addressed whether there was inflation “already extant” in Goldman’s stock price at the time the alleged misstatements were made. Defendants also argued that the alleged misstatements “were not the types of statements that courts have recognized as capable of maintaining in­flation in a public company’s stock price.” Finally, Goldman argued that the alleged misstatements were “so general that a reasonable investor would not rely on” them and thus the statements could not “inflate or maintain a stock price.”  

Plaintiffs responded that “[t]his Court and others have re­peatedly rejected Goldman’s claim that price-maintenance is limited to cases involving ‘fraud-induced’ inflation” and “[the Second Circuit] rejected [Defendants’] attempt to defeat class certification on materiality grounds in the last appeal.”  

The Second Circuit panel hearing this second appeal in ATRS has the opportunity to provide much-needed guid­ance on plaintiffs’ use of price maintenance theory. The most important issues on the table are whether a plaintiff has to establish that there was fraud-induced price inflation of the company’s stock before the misrepresenta­tions were made. Suppose, for example, that a company’s previous financial disclosures had been accurate, but then profits had declined but the company falsely claimed that profits had not declined, preventing the stock price from falling. Does that pattern of behavior not satisfy the re­quirements of price maintenance theory? The case also raises the question of whether price declines following disclosures of the negative information are enough to support “price impact” claims even if the price had not declined in other instances following disclosure of similar information.  

The appeal also raises the issue of whether, as defen­dants contend, the panel should limit price maintenance theory to circumstances “where specific statements . . . (i) offset investor concerns or (ii) confirm[] market expectations, in either case about a material financial metric, product, or event.” If the panel rejects this argument, it would clarify that price maintenance theory applies to misstate-ments that, when corrected, revealed no concrete financial or operational information that had been hidden from the market for the purpose of maintaining the stock price, as well as misstatements whose materiality is in question.  

Finally, the panel’s decision could address a potential ambiguity in the Goldman I decision concerning whether the materiality of the alleged misrepresentations should be considered on a class certification motion.

Statements About [The Absence of] Gender Discrimination Can Constitute Securities Fraud

ATTORNEY: EMMA GILMORE
POMERANTZ MONITOR JULY/AUGUST 2019

With the emergence of the #MeToo movement, courts have seen an increasing number of securities fraud class actions based on allegations involving sexual discrimina­tion, harassment and other types of sexual misconduct. Such misconduct by itself does not constitute securities fraud. The added element that makes it a fraud is some public statement by the company to the effect that it does not engage in such conduct.  

When securities fraud actions involve allegations of sexual misconduct, the claims asserted typically involve public statements issued by a company about corporate values, integrity, and adherence to ethical standards, which are alleged to be false and misleading in light of actual misconduct known inside the company. That is exactly what happened at Signet Corporation.  

The company had gone out of its way to portray itself as harassment-free in its securities filings and other public statements. It highlighted its Code of Conduct, which said that Signet “made employment decisions ‘solely’ on the basis of merit”; that it was “committed to a workplace that is free from sexual, racial, or other unlawful harassment” and does not tolerate “[a]busive, harassing, or other offensive conduct ... whether verbal, physical, or visual”; that it has “[c]onfidential and anonymous mechanisms for reporting concerns”; that it disciplines “[t]hose who violate the standards in this Code”; and that it requires its senior officials to“[e]ngage in and promote honest and ethical conduct.” In its Form 20-F, filed with the SEC, Signet represented that adherence to the Codes, including by senior executives, was of “vital importance.” It represented that, in adopting both the Code of Ethics and the Code of Conduct, the company has “recognized the vital im­portance to the Company of conducting its business sub­ject to high ethical standards and in full compliance with all applicable laws and, even where not required by law, with integrity and honesty.” It said that it was committed to disciplining misconduct in its ranks and providing employees with a means to report sexual harassment with­out fear of reprisal.  

According to the securities class action complaint, reality was far different. The alleged sexual misconduct at Signet was at the heart of an arbitration proceeding (the “Jock” action) brought by approximately 200 allegedly victimized employees. Although the Jock proceeding was supposed to be confidential, some details about the experiences of these employees became public in February 2017 and were published in the Washington Post. Many female em­ployees had accused the company of discriminatory pay and promotion practices based on their gender. There were also credible accusations in the Jock proceeding that Signet had a culture of rampant sexual harassment – including, but not limited to, conditioning subordinate female employees’ promotions to their acceding to the sexual demands of their male supervisors (even those who held the highest positions in the company), and retaliating against those who reported this misconduct. Women alleged that sexual harassment routinely occurred at the company’s “Managers’ Meetings,” where male executives “sexually prey[ed]” on female subordinates.  

As discussed in the previous article in this issue, the recent decision in the Signet securities litigation forcefully rejected defendants’ argument, based on the Second Circuit’s decision in Singh v. Cigna Corp., that descriptions of codes of conduct are always inherently puffery that investors cannot take seriously. Archetypal examples of puffery include “statements [that] are explicitly aspirational,” “general statements about reputation, integrity, and compliance with ethical norms,” “mere[] generalizations regarding [a company’s] business practices,” and generalized expressions of “optimis[m].” As with the gen­eral standard governing materiality, determining whether certain statements constitute puffery entails looking at “context,” including the “specific[ity]” of the statements and whether the statements are “clearly designed to distinguish the company” to the investing public in some meaningful way. Finding that Signet’s statements about its code of conduct were very specific and went well beyond vague generalizations, the court in Signet refused to dismiss the action.  

Because gender issues involving corporate management have moved center stage, in recent years many companies have adopted codes of conduct prohibiting this kind of misconduct, and have discussed those codes in their securities filings and elsewhere. While that is certainly a step in the right direction, it is now clear that systematic violations of those codes can lead to securities claims.  

It is concerning to note that Signet’s egregious misconduct might never have become public, because the employees’ complaints were forced into secret arbitration proceed­ings. It was only by chance that the claims came to light and were picked up by the Washington Post. Mandatory arbitration clauses, a common business practice requiring workers and customers to waive their right to sue the com­pany in court, have kept sexual harassment complaints (such as those in the Jock action) hidden from the public.  

For some time, Democrats have introduced bills to ban or limit arbitration clauses. There now appears to be some bipartisan agreement that such practice raises concerns. Republican Senator Lindsey Graham, the chair of the House Judiciary Committee, recently scheduled a hearing on the topic, saying “in 2019, I want to look long and hard on how the system works; are there any changes we can make?” 

Plantiffs' Attorneys and "Blow Provisions": An Uneasy Coexistence

ATTORNEY: LOUIS C. LUDWIG
POMERANTZ MONITOR JULY/AUGUST 2019

During a settlement hearing on June 18 in the matter of In re RH, Inc. Securities Litigation, U.S. District Judge Yvonne Gonzalez Rogers of the Northern District of California took plaintiffs’ and defendants’ counsel to task for failing to disclose the existence of a confidential side deal between the parties. By all indications, the agreement in question related to a so-called “blow” or “blow-up” provision. Blow provisions provide settling defendants with an option to terminate the settlement agreement if a specified threshold of investors elect to exclude themselves (or “opt out”) of the settlement. Opt-out thresholds can be pegged to the dollar amount of the defendants’ potential exposure to opt outs, the per­centage of the shares purchased by class members, the percentage of shares outstanding, or the percentage of shares traded. From a settling defendants’ standpoint, the rationale is obvious: if too many class members opt out of the settlement, those same class members are likely to pursue their own cases against the defendants based on the same underlying conduct alleged in the class action. This makes the value of the class action settlement far less attractive to the defendants. No one wants to pay millions to settle a class action, only to be subjected to massive subsequent claims from investors who have opted out of the class. Where a defendant cannot sufficiently minimize its liability exposure in potential post-settlement “opt out” cases, settlement of the class action becomes a significantly less palatable proposition. The catch, as it were, is that the presence of an exces­sive number of opt-outs cannot and will not be known until the settlement has been inked, preliminarily approved by the court, and notice has gone out, making the blow provision a kind of insurance policy for defendants.  

While the blow provision-related side deal in RH was referred to in the parties’ settlement agreement, it went unmentioned in the motion for preliminary approval. In response to the omission, the judge ordered the parties to file the confidential agreement with the court under seal and advised both firms that she had informed the entire Northern District bench of the incident and of the firms’ respective identities.  

Given that the RH court characterized the settlement as a good deal for the class, counsels’ decision to bury the confidential agreement, and thereby incur the court’s ire, seems like a major unforced error. Certainly, failing to acknowledge the existence of a blow provision in prelim­inary approval motion is indefensible; indeed, plaintiffs’ counsel in RH acknowledged their “poor job” of disclosing the agreement at the June 18 hearing. Courts have a duty to assess the fairness, reasonableness, and adequacy of proposed class action settlements, an objective that is thwarted where the settlement is presented in an incomplete or misleading manner. On the other hand, plaintiff’s counsel was correct in noting that such agree­ments are “standard” in securities cases. Moreover, it is also quite common for the settling parties to request that blow provisions, which are typically memorialized in separate agreements like the one in RH, be subject to confidential treatment, i.e., that they not be publicly disclosed, even to class members. However, the court itself needs to be informed of the provision.  

On the surface, this type of secrecy seems antithetical to the informative aims of class action settlements: settle­ment proponents (plaintiffs and their counsel) are required to provide adequate notice of the settlement’s material terms to the class; in turn, class members are able to make an informed decision on whether to remain part of, opt out of, or object to, the settlement. More generally, absent class members who are not class representatives, and are therefore not directly involved with the litigation, should be kept abreast of critical developments by the plaintiffs and counsel who seek to represent their interests. This is especially true in cases such as RH, where a class had already been certified prior to the parties’ negotiating a settlement, thus creating, arguably, an even stronger presumption in favor of notice than in instances where a class is certified for the settlement purposes only. A previously-certified class has achieved a continuing and ongoing right to all material information about the case, making it difficult to advance the view that the blow provision’s terms have no bearing on individual class members’ decisions on how to proceed with respect to their claims, as has been argued in the settlement-only class certification context.  

Still, there are good reasons for both plaintiffs and defendants to resist public dissemination of the details of the blow provisions. Most prominently, publishing the number or percentage of opt-outs necessary to “blow up” a settlement may give excessive leverage to opt-out activists and threaten the stability of the settlement. Specifically, a group of class members with knowledge of the terms of the blow provision (and holding the requisite number of shares to trigger it) could band together for the purpose of preventing the settlement, or simply extracting special concessions from the settlement proponents. Even if the group did not initially have enough shares to trigger the termination provision, it could seek to recruit enough additional class members to do so. In cases where the claimed damages per share differ significantly among class members, tying the opt-out threshold to a specified dollar value could serve to impede this type of opt-out activism by making it more difficult to assemble the right mix of class members to trigger the blow provision.

Some courts have found these concerns sufficiently persuasive to warrant non-disclo­sure of supplemental agreements containing the opt-out threshold. Such courts will typically permit counsel to submit the supplemental agreement to the court through confidential means, so that the court’s mandate to review the settlement’s fairness is not impeded. Other courts have required that the supplemental agreement be publicly filed, reasoning that class members are entitled to review all aspects of the deal, even where that entails the possibility of a concerted effort to upend the settlement. Regardless, it does not appear that counsel risk any prejudice by not filing supplemental agreements memorializing blow provisions so long as they (a) refer to the existence of any such agreement in their motion papers and (b) file a timely request for confidential review of the agreement, e.g., a motion to file under seal. Alternately, the settling parties might elect simply to inform the court about the existence of the agreement and their non-intention to submit it in any form, confidential or otherwise, absent a specific order to do so. This course of action is not recommended, not only because it is likely to raise the court’s suspicions about the content of the agreement, but also because the court is then forced to issue a request for information in order to carry out its duty to evaluate the settlement’s fairness.

Plaintiffs and their counsel have no real interest in ensuring that a blow provision or appurtenant side agreement be included as part of a settlement – it is inevitably a condition imposed by defendants for purposes of limiting their own exposure to future cases brought by opt-out class members. Nevertheless, these agreements have become standard practice. This is unsurprising in light of research demonstrating that the number of opt-outs – and the potential for separate opt-out litigation – has increased in recent years. Large class action settlements represent a disproportionate percentage of cases that ultimately face an opt-out: between 2012 and 2014, three of four settlements of $500 million or greater involved opt-outs. Consequently, members of the securities plaintiffs’ bar must learn to effectively balance the informational risk posed by opt-out thresholds with both the notice due to class members and the court’s independent obligation to fully review the terms of class-wide settlements.

Statements About Corporate Legal and Regulatory Compliance Can Constitute Securities Fraud

ATTORNEY: JONATHAN LINDENFELD
POMERANTZ MONITOR JULY/AUGUST 2019

In the wake of the financial crisis of 2008, investors have become more attuned to and concerned about the risks companies face, yet may fail to disclose to the market. Consequently, when previously undisclosed news of, for example, a company’s legal liability is revealed to the market or actually materializes, the company’s stock price may well drop sharply, damaging investors. Over the last few years, investors have increasingly brought securities claims over such conduct, sometimes referred to as “event-driven” litigation.  

In March of this year, the Second Circuit issued a decision in Singh v. Cigna Corp., which had one such event-driven claim which turned on whether the company’s public statements concerning its legal compliance were “material” to investors.  

Singh arose from Cigna Corp.’s acquisition of HealthSpring, Inc. for $3.8 billion in early 2012. Cigna, a health insurance and services company, acquired HealthSpring in order to grow its Seniors and Medicare business segment. At the time of the acquisition, HealthSpring was one of the largest private Medicare insurers in the United States. Accordingly, HealthSpring was heavily regulated by the Center for Medicare and Medicaid Services (“CMS”).  

Prior to the acquisition, HealthSpring had a spotless compliance track record—having never been cited for non-compliance by the CMS. That changed following the acquisition. Although Cigna’s acquisition first appeared to be successful, with HealthSpring becoming Cigna’s largest source of revenue within one year, shortly after the acqui­sition was completed Cigna began to receive CMS notices for non-compliance in its HealthSpring operations.  

Between October 2013 and January 2016, Cigna received a total of 75 Notices of Non-Compliance from CMS, culmi­nating in January 2016, when the regulator imposed severe sanctions on the company. On January 21, 2016, CMS notified Cigna that it would be imposing immediate sanctions which would prohibit it from writing any new Medicare policies, a significant blow to its most profitable business segment. Notably, CMS specifically concluded that “Cigna substantially failed to comply with CMS requirements” and that it “had a longstanding history of non-compliance with CMS requirements” as demonstrated by the receipt of numerous prior notices.  

By November 2016, Cigna had spent $100 million to remedy the problems identified by CMS, and was not yet finished. The sanctions were finally lifted on June 16, 2017.  

Plaintiff, representing a class of investors who purchased Cigna stock after the acquisition, alleged four sets of mis­representations concerning Cigna’s track record of legal compliance. First, Cigna stated in an annual report on Form 10-K filed with the SEC that it had “established policies and procedures to comply with applicable requirements.” Second, the Company repeatedly stated in its annual reports that it “allocate[s] significant resources to [its] compliance, ethics and fraud, waste and abuse programs to comply with the laws and regulations[.]” Third, Cigna acknowledged in its annual reports that failure to comply with state and federal health care laws and regulations can result in “fines, limits on expansion, restrictions or exclusions from programs or other agreements with fed­eral or state governmental agencies that could adversely impact [Cigna’s] business, cash flows, financial condition and results of operation.” Finally, the Plaintiff alleged that Cigna’s Code of Ethics and Principles of Conduct included a quote by one of the officer defendants which stated that it is important for Cigna to do things “the right way,” which includes reporting financial results fairly and accurately. Moreover, the quote continued that “it’s so important for every employee on the global Cigna team to handle[,] maintain, and report on this information in compliance with all laws and regulations.”  

The district court dismissed the action, holding that Cigna’s statements about compliance were so vague and conclusory that they amounted to mere “puffery,” and were so immaterial that investors could not reasonably rely on them. After plaintiff appealed the district court’s decision to dismiss his claims, the Second Circuit reviewed the materiality of the alleged misstatements. A misrepresen­tation is material if “there is a substantial likelihood that a reasonable person would consider it important in deciding whether to buy or sell shares of stock.” The statement must also be “mislead[ing],” which is evaluated not only by “literal truth,” but by “context and manner of presentation.” 

The plaintiff in Singh argued that the each of the three sets of alleged misrepresentations were material and misleading because “a reasonable stockholder would rely on these statements as representations of satisfactory legal compliance by Cigna.” The Second Circuit disagreed, affirming the dismissal.  

First, the Second Circuit characterized the Code of Ethics statement as “a textbook example of puffery,” as it ex­pressed “general declarations about the importance of acting lawfully and with integrity.” Accordingly, the Court found that no investor would rely on such statements.  

Similarly, the Court categorized Cigna’s statements in its annual reports concerning its “established policies” and its “significant”’ allocation of resources to compliance programs as mere “representations of satisfactory compli­ance,” which again, the Court found that no investor would reply upon. In making this determination, the Court dis­tinguished Cigna’s statements in its annual reports from the “descriptions of compliance efforts [which] amounted to actionable assurances of actual compliance” made by defendants in Meyer v. JinkoSolar Holding Co., which were found to be actionable.  

Finally, the Second Circuit found that each of Cigna’s statements in its annual reports were “framed” by acknowledgements of the complexity of applicable regulations. As a result, the Court found that Cigna sufficiently “caution[ed] (rather than [instill] confidence) regarding the extent of Cigna’s compliance,” and therefore, “these statements seem to reflect Cigna’s uncertainty as to the very possibility of maintaining adequate compliance mechanism in light of complex and shifting government regulations.”  

The defense bar has already hailed this decision as a lethal arrow in their quiver, claiming that it “will likely in­crease the dismissal rate of [event-driven securities] claims” and instructing defendants to “rely aggressively on Singh in seeking to have such suits dismissed.” Adam Hakki and Agnès Dunogué, “2nd Circ.’s Logical Take On ‘Event-Driven’ Securities Claims,” LAW360, May 13, 2019.  

Singh, however, is far from the decisive victory the defense bar promotes it to be. In the short time since it was handed down, district courts have continued to uphold securities claims concerning statements of legal compliance. In a recent decision following Singh, Signet Jewelers Limited argued that the Second Circuit’s opinion demanded that the plaintiff’s pleadings concerning Signet’s harassment protections in its Code of Conduct and Code of Ethics did not amount to material misrepresentations, and must be dismissed. Judge Colleen McMahon of the Southern District of New York found otherwise. Judge McMahon explicitly held that “Cigna did not purport to change the well-established law regarding materiality. It did not an­nounce a new legal rule, let alone one deeming an entire category of statements — those contained in a company’s code of conduct — per se inactionable.”  

Signet is not an outlier. In March of 2019, two months after Singh was decided, Judge Louis L. Stanton was presented with alleged misrepresentations in the Code of Ethics of Grupo Televisa, S.A.B., a multinational media conglomer­ate, following criminal charges that the company illegally paid bribes to obtain television rights to the FIFA world cup. Just as in Signet, defendants argued that the statements contained in the company’s code of ethics were mere puffery. Judge Stanton disagreed and found that the broad statements in the code of ethics (affirming the company’s commitment to legal compliance and prohibition of bribery) were actionable because they “were made repeatedly in an effort to reassure the investing [public] about the Company’s integrity, a reasonable investor could rely on them as reflective of the true state of affairs at the Company.”  

The Second Circuit’s decision in Singh demon­strates the importance and challenges of bringing securities claims over legal and regulatory failures by public corporations. The take-away of Singh for securities plaintiffs is that they must be evermore diligent in their pleadings, ensuring that judges are presented with specific and detailed representations concerning a company’s compliance such that in­vestors would be justified in taking them seriously.  Signet and Grupo Telavisia demonstrate that Singh certainly does not ring the death knell for similar types of event-driven litigation. Nevertheless, as the defense bar continues to rely upon this decision, it is critical for securities plaintiffs to monitor the decision’s precedential value. 

The Supreme Court Closes Another Door to Class Arbitration

ATTORNEY: AATIF IQBAL
POMERANTZ MONITOR: JULY/AUGUST 2019

In Lamps Plus, Inc. v. Varela, the Supreme Court issued the latest in a series of recent 5-4 decisions that have transformed arbitration law so as to make it much more difficult for plaintiffs to pursue claims as a class, whether in court or before an arbitrator. Following this decision, if an arbitration agreement is ambiguous about class arbi­tration, courts cannot rely on state contract law to interpret it in a way that best effectuates the contracting parties’ bargain. Instead, courts are now required to adopt a heavy presumption that arbitration agreements always prohibit class actions unless they include explicit authorization for class arbitration.   

These cases involved the Federal Arbitration Act (the “FAA”), a 1925 law intended “to enable merchants of roughly equal bargaining power to enter into binding agreements to arbitrate commercial disputes.” Arbitration offers contracting parties procedural flexibility to tailor a dispute resolution process to their specific commer­cial needs, which may include the efficient resolution of simpler disputes as well as expert resolution of technical disputes using procedural and evidentiary rules tailored to the industry. The FAA sought to overcome judicial hostility to arbitration by requiring courts to interpret and enforce arbitration agreements the same as any oth­er contract—i.e., to apply the same state law governing all other contracts and to effectuate the bargain of the parties instead of imposing courts’ own views of pro-cedural fairness and efficiency.  

However, commercial contracts are very different from most consumer and employment contracts. Procedural flexibility is less likely to be abused in commercial contracts because both parties have a shared incentive to structure a neutral process that can efficiently provide real relief. But in consumer and employment contexts, com­panies know they will be defendants and so have strong incentives to design and impose arbitral procedures that are one-sided at best and sometimes even deliberately inefficient in order to deter plaintiffs from bringing claims. (For example, prohibiting class actions essentially mandates individualized proceedings, which can be pro­hibitively costly and inefficient for many employee and consumer claims.) And in the past decade, the Supreme Court’s conservative wing—driven by its own hostility towards class actions—has not only approved of this prac­tice but has increasingly used the FAA to create its own special rules for arbitration agreements, overriding state laws governing every other type of contract.   

Lamps Plus, Inc. v. Varela illustrates this perfectly. The arbitration agreement in that case was part of an employ­ment contract. Unlike commercial contracts, employment and consumer contracts are usually written entirely by the company and then offered on a take-it-or-leave-it basis. Ordinarily, under the law of all 50 states, any ambiguities in a contract written entirely by a company are interpret­ed against the company and in favor of the employee or consumer. The rationale is that the company had every opportunity to protect its interests by writing clearer contractual language and so should not be able to benefit from any ambi­guities it created.   

But the Supreme Court did not apply this rule. The arbitration agreement did not explicitly authorize or waive class arbitration, but it did suggest in several places that class arbitration was available. First, it stated that “arbitration shall be in lieu of any and all lawsuits or other civil legal proceedings”—and “any and all law­suits” plainly includes class actions. Second, it allowed the arbitrator to “award any remedy allowed by applicable law”—which plainly includes a judgment on behalf of a class. Third and most importantly, the agreement provided for arbitration “‘in accordance with’” the rules of a specific arbitral forum whose rules allowed for class arbitration. As Justices Kagan and Sotomayor pointed out in their dissents, an employee reading the con­tract would have little reason to think they were waiving the right to proceed as a class. Thus, under ordinary contract law, an ambiguous contract like this should be interpreted in favor of the employee. If the employer cared about avoiding class arbitration, it had every opportunity to be clearer.  

Nevertheless, the Supreme Court held that arbitration agreements did not have to be clear in order to prohibit class arbitration. The majority’s stated rationale was that “shifting from individual to class arbitration is a ‘fundamental’ change … that ‘sacrifices the principal advantage of ar­bitration’ and ‘greatly increases risks to defendants” and therefore was so “markedly different from the traditional individualized arbitration contemplated by the FAA” that ambiguity was not enough. However, this rationale had no basis in the FAA, which never specifies any primary “advantage” of arbitration nor favors any particular kind of arbitral proceeding. (If anything, the whole point of the FAA was that contracting parties get to decide what they consider the “principal advantage” of arbitration for them­selves, and courts can’t use their own procedural views as excuses to treat arbitration agreements differently from other contracts.) Rather, as Justice Kagan pointed out in dissent, the Court simply used its “policy view … about class litigation” to “justify displacing generally applicable state law about how to interpret ambiguous contracts.” Moreover, while the conservative majority took great pains to protect corporate defendants from “increased risk,” it ignored the risks that its ruling will create for the other contracting parties, i.e., consumers and employees, who will have no practical remedy to vindicate their contractual rights.  

Notably, class-action waivers outside arbitration agree­ments rarely receive such special treatment, and their enforceability is much less clear. So after Lamps Plus, an arbitration agreement that is silent or deliberately vague about class arbitration is more reliable at blocking class claims than an explicit class-action waiver in a normal non-arbitration contract. This creates some strange incen­tives for companies that might otherwise have no interest at all in arbitration.

SEC Trims Public Company Disclosure Rules

ATTORNEY: BRENDA SZYDLO
POMERANTZ MONITOR: MAY/JUNE 2019

After the stock market crash in October 1929 that led to the Great Depression, public confidence in the markets was at an all-time low. The Securities Act of 1933 and the Securities Exchange Act of 1934 were designed to restore confidence in public markets by providing investors with more reliable information.

On March 20, 2019, without an open meeting, the Securities Exchange Commission (“SEC”) voted to trim certain disclosure requirements for public companies. The only dissenting Commissioner was Robert Jackson. According to the SEC’s March 20, 2019 press release, “[t]he amendments are intended to improve the readability and navigability of company disclosures, and to discourage repetition and disclosure of immaterial information.”

The final amendments are consistent with the SEC’s mandate under the Fixing America’s Surface Transportation (“FAST”) Act. In 2015, Congress mandated the SEC to review Regulation S-K, the rules that describe what public companies must report in public disclosures, and to streamline where possible. The amendments are also based on recommendations in the SEC staff’s FAST Act Report as well as an overall review of the SEC’s disclosure rules. The amendments span a number of topics; the more significant amendments are discussed below.

ELIMINATION OF CONFIDENTIAL TREATMENT REQUEST PROCESS

Specifically, the amendments provide that in regulatory filings, public companies can redact confidential information in material contracts and certain other exhibits without submitting a confidential treatment request. Regulation S-K has been amended to provide that a public company can make this decision on its own, as long as the information is not material and would likely cause competitive harm to the company if publicly disclosed. While issuers will surely find this amendment to be one of the most welcome changes in the new rules, investors will clearly be left with less information, which is troubling.

Commissioner Jackson is also troubled by the new rule. In a March 26, 2019 public statement on the final rules, Commissioner Jackson stated:

The rule . . . removes our Staff’s role as gatekeepers when companies redact information from disclosures – despite evidence that redactions already deprive investors of important information.

***

Historically, we’ve required firms to work with our Staff when sensitive information is redacted from exhibits to registration statements. There are often good reasons for our Staff to permit redactions. But recent research shows that redactions already include information that insiders or the market deem material – showing how important careful review of these requests can be for investors.

Today’s rule removes both the requirement that firms seek Staff review before redacting their filings and the requirement that companies give our Staff the materials they intend to redact. The release doesn’t grapple with the effects of that decision for the marketplace. But one thing is clear: in a world where redactions already rob the market of information investors need, firms will now feel more free to redact as they wish. And investors, without the assurance that redactions have been reviewed by our Staff, will face more uncertainty.

ONLY TWO-YEAR DISCUSSION NEEDED IN MANAGEMENT’S DISCUSSION AND ANALYSIS

The SEC also amended the rules to provide that public companies may disclose less information in the Management Discussion and Analysis (“MD&A”) section of their filings. MD&As, which are the opinions of management, provide an overview of how the company performed in prior periods, its current financial condition, and projected results. This is one of the most closely reviewed parts of a company’s financial statements. Historically, in an annual report on Form 10-K or Form 20-F, a public company was required to address the three-year period covered by the financial statements included in the filing. In the final amendments as adopted, where companies provide financial statements covering three years in the filing, companies will generally be able to exclude discussion of the earliest of three years in the MD&A if they have already included the discussion in a prior filing.

DESCRIPTION OF PROPERTY HOLDINGS

Prior to amendment, the rules provided that public companies must disclose the location and general character of the principal plants, mines and other materially important physical properties of the registrant and its subsidiaries. Because the rule created ambiguity and elicited information that may not have been consistently material, the rules were amended to provide that public companies are required to disclose information about their physical properties only to the extent that it is material to the companies.

TWO-YEAR LOOK-BACK FOR MATERIAL CONTRACTS

Prior to amendment, the rules required companies to file every contract not made in the ordinary course of business if the contract is material and (i) to be performed after the filing of the registration statement or report, or (ii) was entered into not more than two years before the filing. The amended rules limit the application of the two-year look-back requirement for material contracts only to newly reporting registrants.

THE SEC ABANDONS A PROPOSED AMENDMENT REGARDING LEGAL ENTITY IDENTIFIERS

The SEC also decided not to adopt a proposed amendment that would have required companies to include legal entity identifiers (“LEIs”) of the registrant and each subsidiary listed in financial transactions. The LEI is a 20-digit, alphanumeric code that identifies legal entities participating in financial transactions. Given the increasingly complex organizational structures of companies, LEIs provide a precise standard for identifying legal entities responsible for risk-taking. Commissioner Jackson was troubled that this proposed amendment was abandoned. He was particularly concerned that “the financial crisis taught regulators that firms’ complex structures made it impossible to identify the corporate entities responsible for risk taking,” and that the Commission majority had provided “little evidence or reasoning” for eliminating that requirement. He concluded that, overall, the proposed new rules would “rob the market of information investors need to price decisions.”

THE TAKE-AWAY

Pomerantz echoes Commissioner Jackson’s concerns that abandoning a proposed amendment regarding LEIs and trimming certain disclosure rules for public companies rob the market of information investors need to price decisions.

SEC Issues Expanded "Test-the-Waters" Communication Rules

ATTORNEY: ROXANNA TALAIE
POMERANTZ MONITOR: MAY/JUNE 2019

On February 19, 2019, the U.S. Securities and Exchange Commission (the “SEC”) proposed a rule under the Securities Act of 1933, Rule 163B, that would relax regulatory burdens for all issuers, including investment company issuers. Specifically, the new rule would permit all issuers to solicit investor views about potential offerings and to consider these views at an earlier stage than currently is permissible. Such a rule would expand the “test-thewaters” accommodation that is currently available to emerging growth companies (“ECGs”). If adopted, this rule would result in earlier communications with potential investors to assist in evaluating the market and developing relationships with them.

The notion of test-the-waters was originally introduced when Congress passed the Jumpstart Our Business Startups Act (the “JOBS Act”) in 2012. Under the JOBS Act, ECGs are allowed to assess the interest of qualified institutional buyers and institutional accredited investors in connection with proposed securities offerings.

The proposed Rule 163B would allow issuers to engage in oral or written communications with potential investors that are, or that the issuer reasonably believes to be, qualified institutional buyers or institutional accredited investors. A qualified institutional buyer is a specified institution that owns and invests on a discretionary basis at least $100 million in securities of unaffiliated issuers. Institutional investors, including organizations not formed for the purpose of acquiring the securities offered and with assets in excess of $5 million, are considered accredited investors and must meet the criteria of SEC Rule 501(a)(1), (a)(2), (a)(3), (a)(7), or (a)(8), The SEC thus believes that these types of entities do not need the protection of the Securities Act’s registration process as they are more financially sophisticated than an average investor.

An issuer or person authorized to act on the issuer’s behalf would be required only to reasonably believe that a potential investor is a qualified institutional buyer or institutional accredited investor. The SEC failed to provide specific steps that an issuer could or must take to establish a reasonable belief that the intended recipient of the communications is qualified. Instead, the SEC is apparently assuming that issuers can and should continue to rely on current and previous methods used to assess an investor’s status.

SEC chairman Jay Clayton issued a press release announcing the proposed rule with the goal that “[e]xtending the test-the-waters reform to a broader range of issuers is designed to enhance [the issuer’s] ability to conduct successful public securities offerings and lower their cost of capital, and ultimately to provide investors with more opportunities to invest in public companies.”

Proponents of this new rule argue that in allowing more issuers to engage with a set of financially sophisticated institutional investors while the company is in the process of preparing for a securities offering could help issuers assess the demand for and value of their securities. Further, issuers would be able to discern which terms and structural components of the offering would be important to investors before the company incurs costs associated with the launch of an offering.

Ultimately, it appears that the SEC’s goal is to increase registered offerings in the United States. In doing so, the SEC believes that it can “have long-term benefits for investors and [the U.S.] markets, including issuer disclosures, increased transparency in the marketplace, better informed investors, and a broader pool of issuers in which any investor may invest.” According to the Wall Street Journal, the number of public companies has declined by about 50% since the mid-1990s. The JOBS Act failed to substantially increase the number of initial public offerings (“IPOs”) that occurred in the past few years. Close to 40% of eligible ECGs that conducted IPOs took advantage of the JOBS Act test-the-waters provision in 2015, but that percentage fell to less than 25% in 2016. It is difficult to ascertain at this time whether Rule 163B will increase IPOs. If that is the case, one can only hope that the SEC’s goal of providing issuers and investors flexibility and transparency alike does not lead to increased litigation regarding fraudulent claims as we have previously seen in IPOs filed and a company’s related subsequent stock drop.

Taking the potential benefits of Rule 163B into consideration, the next logical question that follows would be how these expanded rules play into the protection that investors would be afforded. Although the new rule would exempt test-the-waters communications and would need not be filed with the SEC, that is not to say that investors are left without any type of protection. The proposed rule provides that such communications would still be considered “offers” as defined under the Securities Act, thereby allowing liability and anti-fraud provisions to continue to be applicable. Further, the information disclosed during communications must not conflict with material information in the related registration statement and, as is the practice of the SEC when reviewing offerings conducted by EGCs, the SEC or its staff can “request that an issuer furnish the staff any test-the-waters communication used in connection with an offering.” Lastly, the SEC cautioned public companies that certain test-the-water communications could trigger disclosure under Regulation FD, which requires public companies to make public disclosure of any material non-public information that has been selectively disclosed to certain securities market professionals or shareholders. To avoid the application of Regulation FD, the SEC recommended having the recipient of the communication enter into a non-disclosure agreement to mitigate the need for public disclosure.

Flexibility and efficiency continue to be touted as reasons why this proposed rule is beneficial. The SEC argues that it will increase access to public capital markets by providing flexibility to issuers regarding their communications and determining which investors qualify under Rule 163B as intended recipients of such communications. As such, companies are in a better position to evaluate market interest and have discussions regarding the transaction terms required to address the most important concerns institutional investors may have, thereby providing a more efficient and effective capital-raising process. By the same token, the goal for investors will be transparency and obtaining information that may allow for more sound, confident financial decisions. Ultimately, investor protection must be at the forefront of any regulation created or amended by the SEC, without which interest in capital markets would greatly decrease.

Proposed Rule 163B was subject to a 60-day public comment period following its publication in the Federal Register. That period ended on April 29, 2019.