The Government Should Tread Carefully in Its Short Seller Investigation

POMERANTZ MONITOR | MARCH APRIL 2022

By Veronica V. Montenegro

In February 2022, it was revealed that the Department of Justice (“DOJ”) and the U.S. Securities and Exchange Commission (“SEC”) commenced an investigation into dozens of investment firms and researchers engaged in short selling. It is not clear yet who on the list is considered a “target” of the probe and who might just have information relevant to the investigation, but the business of short selling in general has caught the attention of regulators.

Short sellers identify a stock that they believe will suffer a decline and borrow shares of that stock from a broker in order to sell them to buyers willing to pay the current market price. If the stock drops, the short sellers make a profit when they return the shares to the broker and buy them at a cheaper price. A short squeeze occurs if the price goes up, and the investors need to rush to buy the stock to cut their losses. Many of those under investigation have made a profession from exposing corporate fraud while betting that companies’ share prices will fall. For their part, some executives, accusing short sellers of targeting their companies for profit, have put pressure on the DOJ and other financial regulators to investigate short sellers for market manipulation. During the early 2021 meme-stock mania, short sellers were especially vilified by retail investors and the Reddit “Wall Street Bets” crowd who intentionally drove up the price of stocks of companies like GameStop and AMC Entertainment, which were heavily shorted at the time. The short squeeze on GameStop saw its share price jump from $17.25 to $325 over the course of just four weeks, posing the risk of catastrophic losses for short sellers as the share price skyrocketed.

It is not entirely clear what the DOJ’s and SEC’s specific allegations of wrongdoing might be, but The Wall Street Journal has reported that federal prosecutors are investigating whether short sellers conspired to drive down stock prices by engaging in illegal trading tactics such as “spoofing” and “scalping.” Spoofing involves flooding the market with a series of fake orders in order to manipulate the stock price without the intention of actually buying the stock. Illegal scalping (as opposed to “legal scalping”) is a short seller influencing investors or otherwise manipulating prices with the intent to sell the stock secretly and profit from the manipulation. U.S. prosecutors are reportedly exploring whether they can bring related charges under the Racketeer Influenced and Corrupt Organizations Act (“RICO”).

The short sellers’ practice of publicizing negative research and profiting when the stock falls has been criticized by those who argue that the allegations can be false and that the traders are artificially deflating share prices to the detriment of shareholders. However, short sellers may be an invaluable source for uncovering corporate wrongdoing and outright fraud. Such short seller reports uncovered fraud at Enron and other corporations and warned of the impending financial crisis in 2008. While companies targeted by short sellers rejoice at the government’s investigation, others believe that the inquiry is premised on the mistaken belief that abuse is widespread and distorting stock prices. Columbia Law Professor Joshua Mitts, one of the biggest critics of short selling, has proposed SEC rules which would require short sellers to hold their position for at least 10 days after releasing their negative research, or be accused of market manipulation for rapidly closing their positions. However, if such rules were to be implemented, they would deprive short sellers—who provide a vital service in policing the markets—of profiting from their research and short positions. In a 2018 research paper titled “Short and Distort,” Professor Mitts looked at 1,720 negative short seller reports and found that the stock prices of targeted companies began to recover just one day after the negative research was published and continued to recover for three days thereafter.

Critics have argued, however, that Professor Mitts did not examine a representative sample of activist short sellers and their reports. For example, Dealbook reported that an analysis shared by Carson Block, the activist short seller who founded Muddy Waters Capital, found that 75% of the negative reports analyzed in “Short and Distort” are not in a database of activist short seller campaigns compiled by Activist Insight, a leading provider.

Additionally, only 20% of the authors of those reports stated that they were shorting the stock of the companies on which they were reporting. Professors Frank Partnoy (Law School at the University of California, Berkley) and Peter Molk (University of Florida Levin College of Law) analyzed 825 negative research reports located in the Activist Insight database between 2009 and 2016 and found that, four years after the release of the reports, the average stock price decline of 573 targeted companies was more than 20%.

The SEC has not indicated whether it will adopt Professor Mitts’ proposed rules, but the government should move carefully when designing rules that can hamstring short selling as a viable profession. Many respected professionals in the securities field believe short selling plays an important role in public markets by improving price discovery and rational capital allocation, preventing financial bubbles, and finding fraud. In the securities class action space specifically, negative research reports authored by short sellers may play a vital role in alerting the market and investors that fraud has been committed by the company. These reports are often cited in class action lawsuits as revealing the truth of the fraud to the market, thereby serving as the “corrective disclosure”—a necessary component of a securities class action. Defendant companies frequently move to dismiss short seller claims, arguing that loss causation cannot be predicated on their reports as corrective disclosures because, among other reasons, the authors had a financial incentive to convince others to sell.

Unfortunately, various federal courts have sided with defendants on this point, with or without the existence of a financial incentive. Even though the information contained in such reports is revelatory of a previously undisclosed fraud, the reports should nevertheless qualify as corrective disclosures. If government action makes short selling a nonviable profession, class action investors would no longer be able to count on their reports to help make their case against fraudulent companies. Additionally, government action that further stigmatizes the role of short sellers could cause federal courts to take an even more skeptical view of short seller reports when analyzing the loss causation element of a securities class action lawsuit. To be clear, securities fraud, in whatever form it takes, should be prosecuted and punished—short selling firms should not be the exception. If the government investigation reveals that the targeted short selling firms have in fact engaged in illegal trading tactics, prosecution is warranted. However, it cannot be denied that short sellers and their reports have aided defrauded investors in prosecuting their cases.

The government should be diligent in ensuring that its investigation targets actual potential market manipulation and is not influenced by disgruntled corporate executives who are simply upset that their companies were subjects of hard-hitting research that revealed fraudulent activity.

Proposed Expanded Scope of Insider Trading Liability

POMERANTZ MONITOR | MARCH APRIL 2022

By Terrence W. Scudieri

On February 15, 2022, the U.S. Securities and Exchange Commission (the “SEC”) published a Proposed Rule in the Federal Register that, if adopted, will significantly expand the scope of liability for insider trading under Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), by limiting the scope of the current affirmative defense provided under SEC Rule 10b5-1 (the “Proposed Rule”). In general, to qualify for the Rule 10b5-1 affirmative defense, a corporate insider may avoid liability for trading on the basis of material, nonpublic information (“MNPI”) if its trade is pursuant to a contract, instruction, or plan that is adopted prior to the insider becoming aware of MNPI (a “Plan”), which either (1) specifies the amount, price, and date of securities to be traded; (2) provides written instructions or a formula that would trigger a trade of securities; or (3) does not allow the insider to influence whether, how, or when trades are made after the Plan is effective. The Proposed Rule signals a revival of the remedial intent of the securities laws: “to insure honest securities markets and thereby promote investor confidence” (United States v. O’Hagan). Indeed, “[a] significant purpose of the Exchange Act was to eliminate the idea that the use of inside information for personal advantage was a normal emolument of corporate office” (In re Cady, Roberts & Co.).

Background

Under Section 10(b), it is unlawful to use or employ, in connection with the purchase or sale of any security, “any manipulative or deceptive device or contrivance in contravention of [the SEC’s regulations].” For decades, courts have held that insider trading on the basis of MNPI is a “deceptive device” within the meaning of Section 10(b) and Rule 10b-5.

In 1997, the Supreme Court set forth two “theories” of MNPI insider trading liability under Section 10(b) and SEC Rule 10b-5. The first, known as the “traditional” or “classical theory,” is relevant here, while the second, known as the “misappropriation theory,” does not target unlawful trading by insiders, but instead “outlaws trading on the basis of nonpublic information by a corporate ‘outsider’ in breach of a duty owed not to a trading party, but to the source of the information.”

The classical theory posits that “Section 10(b) and Rule 10b-5 are violated when a corporate insider trades in the securities of his [or her] corporation on the basis of material, nonpublic information. Trading on such information qualifies as a ‘deceptive device’” within the meaning of Section 10(b) because “a relationship of trust and confidence exists between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position with that corporation,” such that an insider owes a fiduciary “duty to disclose or to abstain from trading” on the basis of MNPI. This theory of liability “applies not only to officers, directors, and other permanent insiders of a corporation, but also to attorneys, accountants, and others who temporarily become fiduciaries of a corporation.”

In August 2000, the SEC promulgated Rule 10b5-1, which clarifies whether an insider’s purchase or sale of an issuer’s securities was “on the basis of” MNPI and under what circumstances such a transaction was tantamount to a “manipulative and deceptive device,” thus giving rise to liability for securities fraud under Section 10(b). In doing so, the current Rule 10b5-1(c)(1) expressly excludes from its definition such insider trades as are made pursuant to a Rule 10b5-1 “plan;” that is, pursuant to a “binding contract to purchase or sell the security” or a “written plan for trading securities” that was ostensibly adopted before an insider became aware of MNPI. These “10b5-1 trading plans are designed to allow corporate insiders to ‘plan future transactions at a time when he or she is not aware of material nonpublic information without fear of incurring liability’” (Sec. & Exch. Comm’n v. Mozilo).

Problematically, current Rule 10b5-1 trading arrangements are often abused “to conduct share repurchases to boost the price of the issuer’s stock before sales by corporate insiders” (Proposed Rule, 87 Fed. Reg. at 8688). Accordingly, the SEC has published the Proposed Rule “to address apparent loopholes in the rule that allow corporate insiders to unfairly exploit information asymmetries.”

Three Key Proposed Changes

The Proposed Rule offers several amendments. This article addresses three of the most beneficial proposed changes for investors: the Proposed Rule would (1) add a 120 day mandatory “cooling off” period before any trading can commence under a Rule 10b5-1 trading arrangement after its adoption, cancellation, or modification; (2) require officers and directors to certify in their SEC filings that they are not aware of any MNPI before adopting a Rule 10b5-1 trading arrangement; and (3) require each issuer to disclose in their annual reports whether it has adopted insider trading policies and procedures, and to disclose such policies and procedures (or the lack of such policies and procedures and the reasons why).

First, at present, there is no mandatory waiting period between the time an issuer adopts a Rule10b5-1 plan and when an officer or director makes a trade pursuant to that plan. The Proposed Rule would prohibit officers and directors from making any trades pursuant to a Rule 10b5-1 plan within 120 days of adopting, cancelling, or modifying such a plan (Proposed Rule, 87 Fed. Reg. at 8689 90). This change is critical, as it should work to solve the current problem of insiders adopting a Rule10b5-1 plan and making trades pursuant to that plan on the same day.

Second, at present, there is no current requirement that officers or directors certify their ignorance of any MNPI before invoking a Rule10b5-1(c) affirmative defense. The Proposed Rule would require officers and directors to certify, at the time of the adoption of the trading arrangement,” that “they are not aware of [MNPI] about the issuer or its securities” and that “they are adopting the [Rule 10b5-1 plan] in good faith and not as part of a plant or scheme to evade [Section 10(b) or Rule 10b-5]” (Proposed Rule, 87 Fed. Reg. at 8691). If adopted, this change may provide an additional basis for Section 10(b) liability.

Third, at present, there is no requirement that issuers disclose in their SEC filings whether they have enacted policies and procedures to protect MNPI from misuse by insiders. The Proposed Rule would require all issuers to disclose (1) their insider trading policies and procedures in their annual SEC reports and (2) whether an issuer, officer, or director used a Rule 10b5-1 trading plan during a reportable quarter in their quarterly SEC reports (Proposed Rule, 87 Fed. Reg. at 8693 94). If adopted, this change may provide an additional basis for Section 10(b) liability.

Conclusion

The Proposed Rule would make many positive changes, and investors are encouraged to review it in full. The SEC is accepting public comments until April 1, 2022, after which it is expected to adopt a Final Rule.

Q&A - Gustavo Bruckner

POMERANTZ MONITOR | MARCH APRIL 2022

By The Editors

Gustavo F. Bruckner leads Pomerantz’s Corporate Governance practice group, enforcing shareholder rights and litigating against corporate actions that harm shareholders.

Monitor: What is a shareholder derivative case?

Gustavo Bruckner: Whether an investor owns one share or one million shares, they are an owner of that company. The company itself is just a legal creation, an inanimate object that cannot respond when it is harmed or wronged. But a shareholder, as an owner, can take action on behalf of the company to remedy that harm. And that’s what a shareholder derivative action is. It’s usually directed against the officers and directors who sit at the top of the company and wouldn’t otherwise take action against themselves.

M: One share versus one million shares… Is weight given to that in court in corporate governance cases?

GB: The other side often tries to make it an issue. There was a recent hearing where a shareholder owned a fractional share of Tesla in one account and many more in another. Tesla argued that the shareholder didn’t own enough to review its books and records. The Vice Chancellor of Delaware’s Chancery Court shut down that argument very quickly. There are jurisdictions where you need to own a certain minimum threshold of the shares to pursue derivative litigation – 5% in Nevada, for example – but not in Delaware, which is the most common forum for these kinds of actions. The law does not specify a minimum; the only thing the law specifies is the ownership stake at the time the litigation is brought. For the most part, one share or a million shares is the same under the law.

M: #MeToo issues like sexual harassment are sensitive matters to the victims involved. How do you maintain discretion and confidentiality?

GB: Our goal is not to promote ourselves. Our goal is to forcefully and effectively represent our institutional and individual clients. If the best way to address the misconduct, remedy the harm, and bring about change is to do it privately, then we will do so. And we’ve had many, many such resolutions. No one will ever know except the parties involved that Pomerantz, on behalf of its clients, caused those changes. It won’t appear in any court docket or in the news. But we cause real substantive, meaningful change through our prosecutions and through the cudgel of litigation.

M: This misconduct is often hidden from public view. How can shareholders gain insight into concealed wrongdoing?

GB: It sometimes comes to our attention through aggrieved parties or whistleblowers. Stockholders may reach out to us based on their feeling that something just doesn’t pass the smell test. And I’ve even had more than one experience where a competitor has said that a situation is worthy of investigation. When you’ve been doing this long enough, you know what doesn’t seem right.

M: What do you foresee being the most important governance matter facing corporations over the next decade?

GB: There are several things at play. We mentioned fractional investing earlier. Robinhood and other similar services have democratized investing even further so shareholder ownership will continue to evolve and look very different from the past. This is already leading to very strong pushes for activism in areas such as climate change, diversity, executive compensation and social action. Companies will have to figure out how to balance the need to maximize stockholder profit while also achieving the social goals of its ownership. Often, maximizing profit for shareholders is at direct odds with achieving ESG goals. And then there are the rules governing corporate behavior. We are already seeing a couple of instances where corporations are trying to avoid or preempt state oversight by adopting bylaws that limit the kinds of actions that can be brought. That may be something that will come to a head in the next few years.

M: On the topic of executive compensation, can you speak to the importance of clawbacks?

GB: The clawback is a tool that every corporation should avail itself of when there is harm caused by executive misconduct but, for a multitude of reasons, companies refuse to both adopt and implement clawback and fallback policies. They claim that if they adopt policies that are too strong, they won’t be able to attract the best and brightest executives. That seems ridiculous to me. Are you recruiting from the white-collar section of the prison to hire your executives? We’re intentionally pretty forceful in looking at clawback policies whenever we investigate a company for misconduct. Many clawback policies only kick in if there’s a financial statement. The largest securities action of the last five or so years was Petrobras. There was no financial restatement in that, so that situation would not have allowed shareholders to go after company executives even after decidedly corrupt and illegal behavior.

M: Over the course of your career, what is the most important corporate governance reform that you have achieved?

GB: It’s actually confidential, but what I can say is that Pomerantz sent a litigation demand to a major entertainment company after reports of sexual harassment. As a result, we were able to negotiate reforms that included formation of a special committee of the company’s board and creation of a Fair Employment Practices Group, along with complete retraining of all of their U.S. employees. The company also agreed to institute increased opportunities for reporting of harassment via the web and phone and we required that reports of harassment reached the highest levels at the company. I am quite proud of this one, feeling it has made a difference for the people there.

Pomerantz Corporate Governance Roundtable

With Special Guest Speaker President Bill Clinton

Pomerantz, in association with The Corporate Governance Institute, Inc., is pleased to announce the agenda for the upcoming Corporate Governance Roundtable Event on June 14, 2022, that it will host at the Waldorf Astoria Hotel in Beverly Hills, California. We are honored that President Bill Clinton will be the special guest speaker.

President Clinton served as the 42nd President of the United States and is the 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. Roundtable attendees can look forward to hearing President Clinton, widely renowned as a gifted speaker, share his perspectives and experiences.

The Roundtable will gather institutional investors from around the globe 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 with the opportunity to discuss important matters that affect the value of the funds they represent. This year’s panels and presentations include the following topics:

Covid-19 and the Litigation Pandemic: The COVID-19 pandemic has produced a tidal wave of new litigation. This session will provide insight into this evolving legal landscape.

Corporate Governance Developments: A discussion of current global trends in corporate governance and a look forward at emerging issues that governance professionals may face in the coming year.

Forced Arbitration and the Repercussions for Institutional Investors: Over the last several years, there have been indications that the SEC is considering allowing corporations to use forced arbitration clauses to curtail investors’ rights to bring securities class actions. This panel will discuss Colorado PERA’s and the CII’s decision to intervene in an action in which a shareholder, represented by an anti-class action activist, seeks to have Johnson & Johnson shareholders vote on a contentious proxy proposal. The proposal concerns a corporate bylaw that would require all securities fraud claims against Johnson & Johnson to be pursued through mandatory arbitration, thus waiving shareholders’ rights to bring securities class actions.

Fiduciary Duty & ESG Priorities in 2022: This session will explore how institutional investors can balance their interest in promoting adherence to good ESG principles at the companies in which they invest with their fiduciary duties to protect investments and maximize fund performance.

Securities Litigation Update: Engagement & Litigation: General Counsel from some of the most influential global institutional investors will discuss their attitudes toward securities litigation and what other tools they employ to hold corporations accountable.

Inside the Boardroom: This panel will discuss how directors address board diversity within their own organizations and how their internal approach impacts their interactions with the boards of companies with which they entrust their investments.

Jennifer Pafiti, Partner and Head of Client Services at Pomerantz, has been involved in organizing the Firm’s Roundtable Events since 2015: “These events bring peers together 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, which adds real value to fiduciaries’ day-to-day roles.”

To express your interest in attending this special event, please email PomerantzRoundtable2022@pomlaw.com

Pomerantz Achieves $90 Million Class Action Settlement in Altria and JUUL Litigation

POMERANTZ MONITOR | JANUARY FEBRUARY 2022

By Michael J. Wernke

In a significant victory for investors, Pomerantz, as lead counsel for the class, has achieved a $90 million settlement in a securities fraud class action against Altria Group, Inc. (“Altria”), JUUL Labs, Inc. (“JUUL”), and certain current and former officers of the two companies. Judge David J. Novak of the United States District Court of the Eastern District of Virginia granted preliminary approval of the settlement on December 16, 2021 and set the final approval hearing for March 31, 2022.

Altria is one of the world’s largest manufacturers of tobacco products, such as Marlboro cigarettes. JUUL is a leading manufacturer of e-cigarettes. On December 20, 2018, Altria announced that it paid $12.8 billion to acquire a 35% interest in JUUL. Pomerantz brought the action on behalf of investors that acquired Altria shares following the investment. The complaint alleges that Altria, JUUL and the officers violated section 10(b) of the Securities Exchange Act as well as section 20(a), the “control person” provision, by misleading regulators, the public, and investors regarding JUUL’s illegal marketing practices that targeted underage consumers.

Specifically, our complaint alleges that when Altria made its investment in JUUL, underage usage of e-cigarettes had increased to epidemic proportions, with JUUL being the preferred brand of teens. Regulators, as well as the public at large, were concerned that e-cigarette companies such as JUUL may have purposefully targeted underage users, as Altria and the rest of “Big Tobacco” had done with traditional cigarettes in decades past. However, when the massive investment was announced, both Altria and JUUL reassured investors that JUUL’s “intent was never to have youth use JUUL products” and that both companies were committed to solving the youth vaping epidemic. JUUL repeatedly stated “[w]e have never marketed to youth and never will.”

The truth was much different – and unsettling. JUUL’s co-founders had carefully studied the marketing tactics previously employed by Big Tobacco to target underage consumers in the hopes they would create lifelong customers for JUUL’s products. They designed and created a technologically advanced product that appealed to the modern underage consumer and delivered highly addictive and dangerous levels of nicotine. In addition to a sleek design that resembled a USB drive that youth could hide in plain sight, JUUL made its products powerfully addictive and enticing, offering an array of kid-friendly flavor options for their JUULpods, including mango, crème brûlée and mint. Lured in by these flavors, youth users experienced JUUL’s nicotine delivery system (in the form of JUULpods), which, by design reduced the harsh effects of traditional combustible tobacco products, minimized the “throat hit” associated with traditional cigarette use, and released nicotine more effectively, making the nicotine impact more potent and likely to cause addiction. During its investment due diligence process, Altria quickly recognized JUUL’s scheme to entice adolescents, because JUUL was mimicking the marketing gimmicks that Altria and the rest of Big Tobacco were caught doing years before. Altria, however, turned a blind eye to JUUL’s improper practices. Altria was desperate to acquire JUUL, regardless of the risks, because Altria was unable to meaningfully compete with JUUL in the burgeoning and lucrative market for e-cigarettes.

When JUUL’s and Altria’s scheme was discovered, and regulators began to act, Altria’s investors (who now owned 35% of JUUL) paid the price. The risks of regulatory scrutiny and extensive litigation from the defendants’ intentional and illegal scheme began to materialize, resulting in Altria taking three separate write-downs of its JUUL investment until it was valued at only $1.6 billion, or 12.5% of its original $12.8 billion investment. As the market learned the truth concealed by the defendants’ fraud, Altria’s stock lost one-third of its value.

The settlement was achieved after approximately two years of hard-fought litigation. The defendants filed four motions to dismiss the complaint, which the court denied in their entirety in March 2021. The court’s opinion was particularly significant because it upheld claims against JUUL in addition to Altria, even though all claims were based on the plaintiffs’ purchases of Altria securities (not JUUL securities). Normally, courts hold that a plaintiff that purchased shares in Company A (Altria) lacks standing to pursue 10(b) claims against a distinct Company B (JUUL) for statements that Company B made about itself. This crucial “standing issue” is one in which there had heretofore been a wide gap in case law.

The court, persuaded by Pomerantz’s arguments on the standing issue, stated that JUUL “can face liability for its own statements that Altria investors may have relied upon.” The court found the alleged statements material, holding that “[p]laintiffs have alleged an abundance of facts showing that JUUL targeted youth and sufficient facts that Altria and JUUL knew of this marketing scheme and the risks that it posed to JUUL and Altria. However, they chose not to inform investors about these risks,” which disclosure “would have altered the ‘total mix’ of information available that a reasonable investor would have considered.” Altria is the first case to present a fact pattern that had previously only been suggested as viable in dicta by circuit courts. In securing this precedent-setting decision, Pomerantz has forged a new inroad for investors’ rights.

Discovery was wide-ranging. It involved analyzing approximately 30 million pages of documents concerning a diverse range of highly complex issues and dozens of depositions. Settlement was only achieved as discovery was ending and the parties were preparing for summary judgment briefing.

Pomerantz’s perseverance resulted in one of the largest recoveries ever achieved in a securities class action in Virginia and in the Fourth Circuit, and which is approximately seven times the median settlement value of all federal securities class actions between 2018 and 2020.

Pomerantz Achieves Victory for Qihoo Investors

POMERANTZ MONITOR | JANUARY FEBRUARY 2022

By Michael Grunfeld

Pomerantz achieved a significant victory for investors when the Second Circuit Court of Appeals vacated the district court’s dismissal of a securities fraud class action against Qihoo 360 Technology Co. Ltd. (“Qihoo”) on November 24, 2021.

Qihoo is a leading technology company in China that provides internet security services and other technology offerings. This case arises out of Qihoo’s management buyout in 2016, followed by the announcement in 2017 that the company would relist on the stock market in China for multiple times what the buyers paid to shareholders in the buyout. A group of buyers that included Qihoo’s top executives took Qihoo private for $9.4 billion in a deal that closed on July 15, 2016. After the buyout, Qihoo split up its businesses and then, on November 2, 2017, SJEC—an elevator-manufacturing company listed on the Shanghai Stock Exchange—announced that it would be conducting a backdoor listing (also known as a reverse merger) with Qihoo’s main businesses. On February 28, 2018, Qihoo’s shares effectively began trading on the Shanghai Stock Exchange; the company had a market capitalization of $62 billion at the end of its first day of trading.

The complaint alleges that that the defendants violated Section 10(b) and other provisions of the Securities Exchange Act of 1934 because they misrepresented that the buyers (including Qihoo’s CEO and President) planned, at the time of the privatization, to relist the company in China. The district court applied an overly demanding standard to conclude that the complaint did not plead a false and misleading statement because it did not adequately allege a “concrete and definite” relisting plan at the time of the buyout, despite the multiple sources of evidence supporting the allegation that the buyers had precisely that plan.

In vacating the district court’s ruling, the Second Circuit explained that the lower court improperly discounted the evidence showing that a relisting plan existed at the time of the buyout. This evidence includes news articles referencing materials provided to investors in the privatization that discussed the relisting plan, an expert’s analysis of the amount of time it takes to plan for a backdoor listing in China, and information from a confidential witness who was at a meeting with one of the defendants. The Second Circuit concluded that these allegations created a “plausible inference that a concrete plan was in place at the time Qihoo issued the Proxy Materials.” This meant that the plaintiffs adequately alleged that “the statement in the Proxy Materials that ‘the Buyer Group does not have any current plans’ to relist Qihoo—as well as its omission of any such plan—was misleading.”

The Second Circuit’s decision contains several notable rulings. First, the decision provides a helpful reminder that “[a]lthough pleading standards are heightened for securities fraud claims, we must be careful not to mistake heightened pleading standards for impossible ones.” This is an important acknowledgment that courts must apply common sense when assessing the plausible inferences that should be drawn from the facts alleged in a complaint at the pleading stage.

In addition, the Second Circuit’s decision is significant in its recognition of what the plaintiffs alleged to be false. The complaint alleged that the defendants’ statement, in the proxy materials for the privatization, that the buyer group did not have any “current plans, proposals or negotiations” for an “extraordinary corporate transaction” was false because the group already had its relisting plan when it made that statement. The district court held that because the proxy materials also noted that after the buyout, the company “may propose or develop plans and proposals” to relist, the plaintiffs faced a higher hurdle in what they were required to show in order to allege the falsity of the defendants’ statements. On appeal, the plaintiffs argued that the defendants’ warning that the company might at some point in the future “propose or develop plans and proposals” to relist has no bearing on whether the buyer group had any “current plans” at the time of buyout. The Second Circuit agreed. Because the complaint plausibly alleged that the buyer group had a plan to relist at the time of the buyout, the defendants’ denial of “any current plans to relist Qihoo” was adequately alleged to be false and misleading.

The Second Circuit’s decision also explains clearly how the materiality element applies here. The plaintiffs argued on appeal that it does not matter how advanced the buyer group’s relisting plan was because the stage of development of the plan relates to the separate issue of materiality, which—particularly in the context of significant corporate transactions—is a fact-intensive issue that cannot be decided on a motion to dismiss. The Second Circuit again agreed. It stated the well-known standard that “a complaint may not properly be dismissed on the ground that the alleged misstatements or omissions are not material unless they are so obviously unimportant to a reasonable investor that reasonable minds could not differ on the question of their importance.” The Court also cited cases holding that this standard is particularly important in the merger context, where “the materiality of merger negotiations depends on the specific facts of each case.” For example, information concerning merger negotiations has been held to be “material even when negotiations had not jelled to the point where a merger was probable.” Applying these principles to the facts alleged here, the Court held that because the plaintiffs adequately alleged that negotiations for the relisting “were ongoing—or had already happened— at the time of the shareholder vote,” these facts were not “‘so obviously unimportant to a reasonable investor’ as to allow the dismissal of the appellants’ claims.”

This decision in Qihoo has considerable implications for other cases that raise similar issues. Qihoo is one of several Chinese companies that have gone private from U.S. exchanges in recent years and relisted shortly thereafter on a foreign stock exchange for multiple times the price they paid to investors to take the company private. Other Chinese companies might soon follow, based on recent political and regulatory developments involving Chinese companies that are listed on U.S. exchanges. Multiple other courts have relied on the district court’s now-vacated decision in Qihoo when deciding that a relisting plan was not adequately alleged. Those other courts, as well as courts that address claims about future relistings, will need to apply the Second Circuit’s important Qihoo decision to the facts before them.

Pomerantz Secures Important Ninth Circuit Ruling in Nikola

POMERANTZ MONITOR | JANUARY FEBRUARY 2022

By J. Alexander Hood II

On November 18, 2021, Pomerantz LLP and Block & Leviton LLP were appointed as co-lead counsel in a securities class action on behalf of investors in the securities of Nikola Corporation, on behalf of a group of three individual investors serving jointly as co-lead plaintiffs. The co-lead counsel appointment in Nikola was the culmination of a 14-month process that began in September 2020 and included a successful petition to the Ninth Circuit Court of Appeals for a writ of mandamus, securing an opinion that provided important clarity to the lead plaintiff appointment provisions of the Private Securities Litigation Reform Act of 1995 (the “PSLRA”).

In September 2020, the first of several related class actions complaints was filed in the United States District Court for the District of Arizona on behalf of Nikola investors, alleging that Nikola and its founder and Executive Chairman, Trevor Milton, had defrauded investors by, among other things, claiming to have designed technology and vehicle components that Nikola had, in reality, purchased from other manufacturers, and wholly fabricating the existence of a purportedly “breakthrough” battery system that Milton claimed was under development. After Nikola’s malfeasance was laid bare, that value of the company’s securities plummeted, damaging investors.

On the November 16, 2020 motion deadline, the Pomerantz LLP and Block & Leviton investor group (the “P-BL Group”) was one of several movants to seek appointment as lead plaintiff in the Nikola class action, alleging an aggregate loss of $6 million.

The PSLRA, which governs federal securities class actions, provides a three-step analysis for the appointment of a lead plaintiff. Specifically, the statute creates a strong presumption that a court will appoint the movant or group of movants that: (1) possesses the largest financial interest (generally meaning monetary loss) in the litigation; and (2) has made a preliminary showing that it is adequate and typical under Federal Rule of Civil Procedure 23—that is, that the class representative’s interests are not antagonistic to those of the class and its claims against the defendants arise from the same course of conduct as those of the other class members. After a movant has satisfied those two criteria, a competing movant may attempt to rebut the presumption in favor of that movant’s appointment by presenting proof that the presumptive movant is in fact atypical or inadequate to represent the class, or otherwise subject to some disqualifying unique defense (Step 3 of the analysis).

Considering the competing motions in Nikola, the district judge applied the PSLRA’s three-step analysis. At Step 1, the district judge recognized that the P-BL Group’s $6 million loss was “millions higher than any other would-be lead plaintiff,” giving the group the largest financial interest in the litigation. At Step 2, the court likewise found that the group was both typical and adequate.

Having satisfied the requisite financial interest and adequacy and typicality criteria at Step 1 and Step 2, the district judge found that the P-BL Group was the presumptive lead plaintiff.

Turning to Step 3, however, the district judge found that competing movants had rebutted the presumption in favor of the group’s appointment as lead plaintiff. Despite finding that the group’s submissions had demonstrated its adequacy under Rule 23, the court considered arguments made by two competing movants—specifically, that the P-BL Group’s submissions had not demonstrated that it was sufficiently cohesive and prepared to supervise the litigation, given that its members lacked a pre-litigation relationship—and expressed “misgivings about the cohesion of [the group] and its ability to control the litigation without undue influence from counsel.” On that basis, the court denied the group’s motion and appointed instead an individual movant, Angelo Baio, with a significantly smaller loss than the group.

Pomerantz and co-counsel promptly filed a petition for a writ of mandamus with the Ninth Circuit Court of Appeals, arguing that the district judge had erred in applying the PSLRA. Specifically, having determined that the P-BL Group had secured the “most adequate plaintiff” presumption after reviewing the evidence in the record, the judge could not then, at the next stage of the analysis, cite the same evidence that had established the presumption in the group’s favor as the basis for “misgivings” and deny the group’s motion.

The Ninth Circuit panel agreed that the district court had misapplied the statute and issued an opinion largely adopting Pomerantz and B&L’s arguments: “For the presumption to have meaning at step three, competing movants must point to evidence of inadequacy. Competing movants must convince the district court that the presumptive lead plaintiff would not be adequate, not merely that the district court was wrong in determining that the prima facie elements of adequacy were met. That is the purpose of the presumption and burden-shifting. The district court made a prima facie determination at step two that the group was adequate. But at step three, it appeared to change its mind because other courts usually prefer members of the group to have a pre-litigation relationship. It pointed to no evidence to support its decision, instead relying only on the absence of proof by the group regarding a pre-litigation relationship and its misgivings. That does not comport with the burden-shifting process Congress established in the PSLRA.”

Accordingly, the Ninth Circuit vacated the lead plaintiff order and remanded to the district court “to redetermine the lead plaintiff in a manner that is consistent with this opinion.”

On remand, the district judge duly applied the statute in a manner consistent with the Ninth Circuit’s opinion. At Step 1, nothing changed in the court’s analysis, as the group having the largest financial interest was never in dispute. This time, however, at Step 2, the court expressly considered the group’s lack of a pre-litigation relationship in making an adequacy determination, as the Ninth Circuit acknowledged it could have done in the first instance. After considering the relevant factors, including the group’s relatively small size and the prosecution procedures and communication mechanisms that the group attested to having adopted, the court ultimately reaffirmed its finding that the group was adequate, its lack of a pre-litigation relationship notwithstanding. Finally, at Step 3, the court found that no evidence had been adduced to the effect that the P-BL Group, as the presumptive “most adequate plaintiff,” was inadequate, atypical, or subject to some disqualifying unique defense—expressly noting this time that the competing movants’ arguments about the group’s unrelatedness had already been addressed at Step 2.

Accordingly, the district court vacated Baio’s appointment as lead plaintiff and appointed the P-BL Group as lead plaintiff instead.

This represents a significant achievement by Pomerantz and Block & Leviton. Guidance from the federal appellate courts on PSLRA jurisprudence is relatively rare, and the Ninth Circuit’s issuance of an opinion, adopting in larger part the arguments advanced by Pomerantz and Block & Leviton, brings important clarity to a sometimes overlooked but nonetheless essential aspect of federal securities litigation. Moreover, the case against Nikola has only grown more compelling since the initial complaints were filed. In July 2021, Nikola’s founder and former CEO, Trevor Milton, was indicted for fraud by federal prosecutors, and in December 2021, Nikola agreed to pay $125 million to settle fraud charges with the U.S. Securities and Exchange Commission.

Q&A - Charlie Morris

POMERANTZ MONITOR | JANUARY FEBRUARY 2022

By The Editors

The Monitor recently interviewed Charlie Morris, Chief Investment Officer, EMEA & APAC, at Woodsford Litigation Funding.

Monitor: What led you to a career in litigation funding?

Charlie Morris: Although, as the son of a criminal law judge, the law is in my blood, I studied modern languages at university. But after living in Japan for a couple of years after graduation, I took the plunge to become a commercial solicitor in the U.K. Several years of study and training later, I qualified as an English law litigator. Right from the off, and for the next seven years, I acted for plaintiffs in funded matters as well as for funders in various disputes about costs. Joining Woodsford allowed me to work in a business in which I continue to use my legal training.

M: Under what conditions might it be advantageous to pursue securities litigation outside the United States?

CM: Put simply, where a listed issuer has failed in its obligation to disclose material information to the market in a timely manner and that failure causes loss to its investors, those investors may have good cause to bring a securities claim. But the devil is in the detail. The specific ingredients required for a good securities claim vary from jurisdiction to jurisdiction. Some regimes are more claimant-friendly than others. For example, in some jurisdictions there is no requirement for claimants to prove ‘reliance’ (e.g. on published information or misrepresentations) or scienter (i.e., that a defendant was, at a sufficiently senior level of management, aware, negligent, fraudulent and/or dishonest in relation to the company’s relevant disclosures). Whereas other jurisdictions do require that claimants prove reliance and scienter.

M: What is litigation funding and what is its role outside the US?

CM: The costs of litigation (anywhere in the world) can be prohibitive. Many claimants with meritorious claims either cannot afford to litigate or lack the appetite to do so. A litigation funder can fund the claimant’s claim in return for a share of any recovery (if the claim succeeds). And if the claim does not succeed, the funder, not the claimant, bears the costs of a loss. Litigation funding is available for all sorts of claims, particularly high value commercial claims. The advantage for institutional investors of having their non-U.S. securities claims funded by a reputable litigation funder like Woodsford is that the merits of their claims will be independently assessed by litigation experts, with the funder bearing the financial risk of it not succeeding. Funding allows institutional investors to comply with their stewardship obligations, by holding their investee companies to account, and to recover losses suffered without having to risk throwing good money after bad. Rarely will it make sense not to participate, even where it is necessary to actively ‘opt-in’ to participate.

M: What are the criteria for a case to be eligible for funding?

CM: Given that funders typically only recoup their investment in a claim and make a return if a sufficient recovery is made, a claim will typically only be eligible for funding if the funder has a clear line of sight to such a recovery. For example, if a claim is meritorious and likely to result in a favorable judgment, but the defendant is unlikely to be able to pay that judgment, the claim is unlikely to be eligible for funding. In a nutshell, a funder typically looks for a trustworthy claimant with a meritorious claim (in respect of liability, causation and quantum), to be heard by a reliable court or tribunal in an efficient manner, against a solvent defendant with sufficient assets in a jurisdiction where effective enforcement (if required) is possible.

M: What is the relationship between Woodsford and the legal team running a case?

CM: Although Woodsford can and does fund law firms, it will typically fund claimants. The claimants, in turn, will instruct and be the clients of the lawyers. The funder and lawyers may also have a direct contractual relationship in that scenario, but that is not always necessary. In securities actions that Woods[1]ford funds, Woodsford typically identifies the law firm that it wants to act for the claimants, agrees to the best possible terms for the claimants and then presents the opportunity (sometimes jointly with the lawyers) to eligible investors.

M: In your 6+ years at Woodsford, what changes have you seen in international securities litigation?

CM: Ever since the U.S. Supreme Court’s 2010 decision in Morrison v National Australia Bank, which saw the U.S. Courts limit the jurisdictional scope of the U.S. securities laws to U.S.-listed securities, international (or non-U.S.) securities litigation has grown significantly. This growth has been fuelled by the simultaneous growth in litigation funding. Funders have become more comfortable with the risks involved in securities litigation in various jurisdictions across the globe while investors are becoming ever more accustomed to what is involved in securities litigation outside of the U.S. Woodsford funded its first international securities litigation in 2017 and has funded many more since. It is funding more English securities claims than any other funder in the market. In a number of jurisdictions, there is little jurisprudence in securities litigation, primarily because most claims settle before trial and judgment. This lack of jurisprudence means that the parties to the litigation are often defining the boundaries of how securities litigation works in a particular jurisdiction. For example, in England, the court has been asked to intervene in some cases to determine what is required for a claimant to have the requisite title to sue. In the Netherlands, there is a question mark over which law governs the dispute where the issuer is seated in the Netherlands but its securities are listed elsewhere. The more securities claims that are brought, the more defined the parameters in these non-U.S. jurisdictions will become, but for the time being, there are various uncertainties. It may be, however, that these uncertainties increase the prospects of settlement, as they exist for the defendant as much as they do for the claimants.

M: Are there common hurdles in persuading investors to join international group actions?

CM: Yes, most investors have the same concerns. They typically want to minimize or extinguish any costs risk, maintain as low a profile as possible, and minimize the management time required to progress the claims.

M: Can you describe a personal career highlight at Woodsford?

CM: In 2018, Woodsford funded a securities litigation against a bank that had engaged in serious, undisclosed wrongdoing. Within a year of commencing proceedings, the investors achieved a highly positive settlement without having to engage in substantive litigation. That outcome was satisfying for me personally and catapulted Woodsford’s securities business into what it is today.

Pomerantz Achieves Corporate Governance Reform at Troubled State Street

POMERANTZ MONITOR | JANUARY FEBRUARY 2022

By Daryoush Behbood

State Street Corporation is an American financial services and bank holding company headquartered in Boston, Massachusetts. It is the second-oldest United States bank, with operations worldwide and trillions of dollars of assets under management.

However, over the course of many years, State Street was encumbered with numerous high-profile problems. In 2015, State Street disclosed that for nearly twenty years, it had incorrectly invoiced clients for out-of-pocket expenses (expenses billed as the actual cost State Street was incurring). While the company paid back more than $370 million to customers, its reputation took a substantial hit. In January 2016, the SEC announced that State Street Bank and Trust Company (“SSBT”), a wholly owned subsidiary of State Street, had paid $12 million to settle claims that a senior vice president of SSBT’s public funds group caused State Street to enter into improper lobbying agreements to facilitate SSBT’s ability to obtain custody services contracts with state pension funds. The SEC also alleged that the senior vice president and an outside lawyer for State Street made and facilitated improper political campaign contributions, contrary to SSBT’s Standards of Conduct for employees, for the same purpose.

In April 2016, two former State Street executives were charged with defrauding State Street clients through undisclosed commissions applied to billions of dollars in securities trades. According to the U.S. indictment, the executives and others illegally conspired (from at least February 2010 to September 2011) to add more than $20 million in secret commissions to fixed income and equity trades performed for at least six of State Street’s institutional clients. One executive pled guilty and the other was convicted in a jury trial for conspiracy, securities fraud, and wire fraud. State Street ultimately paid $64.6 million to resolve civil and criminal investigations related to the allegations. Finally, in July 2016, State Street announced that it would pay $530 million to resolve regulatory and class action claims that it misled certain custody clients related to how the company priced indirect foreign exchange trades.

All in all, these issues caused State Street to pay over $1.2 billion in reimbursement and penalties, harming not only the company itself, but State Street’s many shareholders. To vindicate its shareholders’ rights, Pomerantz, on behalf of two of its clients (State Street shareholders) sent a letter to State Street’s Board of Directors demanding that it undertake an independent internal investigation concerning: (i) the overbilling of clients; (ii) the payment of $12 million to settle charges that the company devised a pay-to-play scheme with respect to Ohio pension funds; (iii) undisclosed commissions applied to billions of dollars in securities trades; and (iv) the $530 million settlement with regulators and public pension funds to resolve foreign exchange fraud claims.

As alleged in the complaint that was eventually filed by Pomerantz on behalf of State Street shareholders, despite the demand letter, the company’s then Board of Directors failed to take any meaningful action towards resolving the weaknesses in its corporate governance that led to the numerous issues outlined above. After a three-year investigatory process, however, the plaintiffs and State Street were able to reach a settlement agreement that required the company to implement and maintain a comprehensive collection of corporate governance and internal control reforms. The reforms included the following:

First, State Street’s Board of Directors was required to revise its corporate governance guidelines to specify that it would be explicitly responsible for overseeing management’s assessment of the adequacy and effectiveness of internal controls, ensuring, in no uncertain terms, a compliance oversight function at the Board level. The importance of the Board’s oversight function cannot be overstated. Creating a compliance oversight function at the board level is extremely important because it elevates the compliance function, separate and apart from management. The targeted language added to the Board’s guidelines will remedy the responsibility gap at State Street and help prevent the recurrence of problems that were previously overlooked, such as overbilling and overcharging State Street clients for out-of-pocket expenses.

Second, the settlement required State Street to develop, implement, and assess a “culture training program” specifically for newly hired employees. The culture training program was designed to promote high ethical standards at the company, create awareness of the risks of unethical business conduct not only for individual employees, but for State Street as an institution, and more generally to prevent the recurrence of employee misconduct that caused the company to pay millions of dollars in penalties, fines, and restitution. Finally, the settlement required State Street to maintain a large suite of policies and procedures, thirty-eight in total, on a wide variety of fronts and in potentially high-risk areas, including billing, contracts, anti-fraud policies, marketing, ethics, and client invoicing. The settlement binds the company to keep these policies and procedures in place for three years, which will considerably strengthen State Street’s internal controls, compliance with state and federal laws, promote appropriate business conduct, and force cultural changes that will persist into the future.

Overall, the corporate governance reforms specified within the settlement were designed to reduce the risk of the recurrence of issues such as those alleged within the plaintiffs’ complaint, and they positioned the company to profit from the long-term benefits of strong corporate governance. Considering the substantial benefits provided to State Street and its shareholders via the settlement, Pomerantz’s clients, and all State Street shareholders, expect that the company’s worst days are behind it.

A Pivotal Moment for the PSLRA's Discovery Stay? Not So Fast.

POMERANTZ MONITOR | NOVEMBER DECEMBER 2021

By Louis Ludwig

The Supreme Court’s unanimous 2018 opinion in Cyan, Inc. v. Beaver County Employees Retirement Fund held that (i) state courts have jurisdiction to hear class actions brought under the federal Securities Act of 1933 (the “Securities Act”) and (ii) the Securities Litigation Uniform Standards Act (SLUSA) does not empower defendants to remove class actions alleging only Securities Act claims from state court to federal court. While these resolved previously-disputed matters, Cyan opened the door to another issue of great importance: Does the provision in the Private Securities Litigation Reform Act (PSLRA), which requires that “in any private action arising under” the Securities Act, “all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss,” apply to Securities Act cases brought in state court, or is its application limited solely to such cases brought in federal court?

On July 2, 2021, the Supreme Court granted the petition for writ of certiorari in Pivotal Software v. Tran to address precisely this question. Pivotal was named in a federal securities class action relating to alleged misrepresentations made in connection with its IPO. The federal suit against Pivotal was dismissed for failure to state a claim, but plaintiffs in parallel state proceedings then sought discovery from Pivotal, leading the company to seek resolution from the Supreme Court.

The PSLRA, enacted by Congress in 1995, established a “stay of discovery provisions” until after a complaint is sustained over defendants’ motion to dismiss or defendants answer the complaint, whichever comes first. Congress reasoned that “discovery should be permitted in securities class actions only after the court has sustained the legal sufficiency of the complaint,” except “in the exceptional circumstance where particularized discovery is necessary to preserve evidence or to prevent undue prejudice to a party.” This broad stay of discovery was supposedly intended to prevent plaintiffs from leveraging the threat of damaging and costly discovery to achieve favorable settlements, especially where a complaint was meritless and unlikely to survive a motion to dismiss.

While the PSLRA’s discovery stay, on its face, applies to “any private action” arising under subchapter 2A of Title 15 of the US Code, which includes the Securities Act, some state trial courts have concluded that the discovery stay is a procedural rule that does not apply to them. Other courts have determined that applying the stay would undermine Cyan’s recognition of state court jurisdiction over the Securities Act. Still other courts have reasoned that SLUSA’s guidance that “a court may stay discovery proceedings in any private action in a State Court” would be superfluous if the PSLRA stay of discovery applied to state court actions. In Cyan’s wake, with more plaintiffs bringing Securities Act claims in state court, the divide has only deepened between these courts and those that interpret the PSLRA’s “any private action” language as requiring them to enforce the discovery stay.

In support of universalizing the PSLRA discovery stay, defendants have argued that state courts are generally more lenient than federal courts in their pleading standards for fraud; that state court judges typically have less experience with securities claims, thus giving rise to increased uncertainty; and that state courts frequently allow shareholders to assert discovery demands before judges have ruled on dismissal motions.

Yet objections to a lack of uniformity between state and federal Securities Act litigation seem more redolent of an invitation to revisit Cyan rather than to focus on the comparatively narrow discovery stay issue. Indeed, the fact that state courts can – and do – decide whether to permit early discovery on a case-by-case basis muddies the claim that state courts are a free-for-all, discovery-wise. Nor is the discovery stay sacrosanct in federal court; to cite one example, in Blitz v. AgFeed, litigated in the Middle District of Tennessee, Pomerantz attorneys successfully moved to lift the stay in order to depose a director who oversaw an investigation into the same accounting misconduct at issue in the lawsuit. Defendants’ post-Cyan cri de coeur elides cases like AgFeed and others where some discretion would make sense: for example, federal securities defendants seeking dismissal routinely point to plaintiffs’ failure to cite damning internal reports as a basis to get rid of the suit. No doubt such defendants are also big fans of the PSLRA discovery stay that prevents plaintiffs from actually obtaining such documents at the pleading stage.

In Pivotal, after the federal action was dismissed, plaintiffs pursued discovery in a parallel securities class action in state court. Pivotal argued, to no avail, that the PSLRA’s discovery stay applied to both the state trial and appellate courts. Pivotal sought review by the Supreme Court, with its petition for certiorari arguing that “[i]t is time for this Court to step in” and suggesting that, absent Supreme Court review, the split among state trial courts was unlikely to be resolved.

On August 26, 2021, just as the Supreme Court was close to hearing arguments in Pivotal, the parties informed the Court that they had “reached an agreement in principle to settle the case ... subject to approval by the Superior Court of California.” When that happens – as seems likely as of this writing – the parties will move for dismissal of the Supreme Court case, leaving the dispute where it was when the Pivotal defendants moved for certiorari, i.e., at square one. Moreover, in the current political climate, it seems unlikely that Congress will enter the securities law fray as it did over 25 years ago via the PSLRA.

Even without a Supreme Court decision mandating that the stay be applied across the board, the much-discussed increase in state court Securities Act filings after Cyan may have been stanched by a less direct tactic favored by issuers. In 2020, the Delaware Supreme Court held, in Salzberg v. Sciabacucchi, that Securities Act forum selection clauses included in companies’ offering documents are facially valid. Unsurprisingly, given the Delaware Supreme Court’s outsized influence on corporate law (itself a by-product of Delaware’s dominance of the corporate incorporation business), state court Securities Act filings have decreased since Salzberg, as companies preemptively divert potential securities suits to federal court.

Assuming that most companies adopt the federal forum provisions as part of the process of going public, the scope of the PSLRA discovery stay may ultimately prove to be a moot point. However, in the event that state court filings increase post-pandemic, or if the holding of Salzberg is somehow limited, then the likely settlement in Pivotal will not prevent another aggrieved defendant from seeking review all over again.

Will ESG Disclosure Rules Force Corporations to Come Clean?

POMERANTZ MONITOR | NOVEMBER DECEMBER 2021

By Elina Rakhlin

The Covid-19 pandemic, with its resultant lockdowns, has inadvertently exposed the extent to which business activity drives greenhouse gas emissions. In 2020 alone, U.S. greenhouse gas emissions experienced the largest one-year decline since at least World War II. But 2020’s emission reductions were in large part due to decreased economic activity resulting from measures put in place to slow the rate of Covid infection, reduced travel, and changes in demand for goods and services. With much of the population now vaccinated and many returning to work in 2021, emissions will likely rise again. Professor Petteri Taalas, Secretary-General of the World Meteorological Organization, said that while “the Covid-19 pandemic is not a solution for climate change … it does provide us with a platform for more sustained and ambitious climate action to reduce emissions to net zero through a complete transformation of our industrial, energy and transport systems.” This environmental call to arms has been echoed by President Biden and his administration, who have put pressure on organizations to address environmental, social, and governance (ESG) related issues. Similarly, the Securities and Exchange Commission (SEC) has made ESG a priority and weighed in to help drive consistency and transparency for public market disclosures.

Some companies, not waiting for the SEC to direct them on which ESG risks should be disclosed, have already marketed themselves as adhering to ESG best practices. According to a September 2020 report from Morningstar, sustainability-focused index fund assets have doubled in the past three years, to more than $250 billion as of mid-2020. In the U.S., sustainable index funds have quadrupled, now representing 20 percent of the total. No doubt the public’s changing attitudes towards diversity, inequity, climate change, and social unrest are driving factors behind institutional investors’ interest in ESG issues. A September 2019 survey conducted by Morgan Stanley’s Institute for Sustainable Investing found that “[m]ore than eight in ten U.S. individual investors now express interest in sustainable investing, while half take part in at least one sustainable investing activity.” It remains to be seen just how many of these so-called sustainable funds and ESG-labeled investment products are misrepresenting themselves to take advantage of the commercialization of ESG issues – a marketing tactic known as greenwashing.

Earlier this year, the SEC formed its first Climate and ESG Task Force within the Division of Enforcement. According to SEC Commissioner and Acting Chair Allison Herren Lee, its purpose is to “work to proactively detect climate and ESG-related misconduct, including identifying any material gaps or misstatements in issuers’ disclosure of climate risks under existing rules and analyzing disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies.” On August 25, the Task Force showed its teeth, pressuring managers of ESG-labeled investment funds to demonstrate that they’re being honest with consumers about their ESG-labeled investment products. The Wall Street Journal reported that the SEC and federal prosecutors were investigating DWS Group, an asset management arm of Deutsche Bank, for alleged ESG-related fraud, after its former head of sustainability claimed the firm overstated how much it used sustainable investing criteria to manage its assets. This investigation into DWS may signify the beginning of a larger SEC crackdown on potentially deceptive ESG promises.

In August 2021, InfluenceMap, a London-based nonprofit, announced the results of its analysis of ESG and climate-themed funds, reporting that 55 percent of funds marketed as “low carbon,” “fossil fuel free,” and “green energy” had grossly exaggerated their environmental claims, with more than 70 percent of ESG funds falling short of their goals as well.

In September 2021, SEC Chair Gary Gensler provided a little more insight into the Commission’s ESG requirements. He reiterated the increasing demand from investors to “understand the climate risks, workforces, and cybersecurity risks of the companies whose stock they own or might buy.” Gensler has tasked his staff with reviewing current practices and developing a proposal for climate risk disclosure requirements for the SEC’s consideration. Additionally, the SEC Chair mentioned that the Commission would be pursuing similar disclosure requirements when it comes to human capital and board diversity.

Although it has not yet adopted final ESG disclosure rules, the SEC proposed proxy voting rules that would require funds to clearly disclose their votes on shareholder and management proposals in relation to their ESG claims. The proposed plan would amend Form N-PX, which requires funds to publicly report their proxy voting records annually, to include many new categories established by the SEC that funds could then use to correspond and report their votes on ESG-related topics. The SEC is additionally proposing that institutional investment managers also be subject to section 13(f) reporting requirements on “how [they] voted proxies relating to shareholder advisory votes on executive compensation (or ‘say-on-pay’) matters.” In a September 29 Commission meeting to consider the proposal, Gensler said that the proposed say-on-pay requirements would allow investors to understand and analyze proxy voting information more easily. The proposed rules may have actually left many funds more dazed and confused about disclosure requirements, but this is only the beginning of the SEC’s ESG-related regulations.

On October 5, 2021, Gensler told Congress that the SEC is considering phasing in its anticipated climate requirements, which will require companies to report their greenhouse gas emissions and climate change risk management plans. Still to be determined is whether compliance would vary based on company size and the different types of climate-related disclosures that may be required.

The SEC is expected to propose its new rules soon, possibly requiring companies to publicly disclose climate risks in their annual 10-Ks or other filings. Additional quantitative reporting may be required of greenhouse gas emissions and any financial impacts of climate change, as well as qualitative disclosures on executive management of climate risks and how climate change factors into a company’s business strategy.

It remains to be seen when we can expect final SEC guidance on disclosure requirements, or how they will affect companies going forward. But one thing is certain: the SEC is closely watching ESG-labeled funds and investment products and will hold them accountable for any misrepresentation and deceptive ESG-related practices.

Q&A: Professors Daniel J. Capra and Stephen A. Saltzburg

POMERANTZ MONITOR | NOVEMBER DECEMBER 2021

By the Editors

Do defendants in securities fraud class actions bear the burden of persuasion when seeking to rebut the presumption of reliance originated by the Supreme Court in its landmark decision in Basic, Inc. v. Levinson, or do defendants bear only the lower burden of production? In early 2021, Partner Emma Gilmore led a team of Pomerantz attorneys and twenty-seven of the foremost evidence scholars in drafting an amicus brief in Goldman Sachs Group, Inc. et al v. Arkansas Teachers Retirement System, et al. (No. 20- 222) – the sole brief submitted to the Supreme Court on this hot-button issue. Emma spoke with two of those experts – Daniel J. Capra and Stephen A. Saltzburg – about the SCOTUS decision that sustained their argument.

Monitor: Please share the journey you took to becoming an evidence expert.

Professor Capra: My road to expertise began with learning from the best --- Professor Steve Saltzburg. After that, I was lucky enough to be appointed as a Reporter to the Judicial Conference Advisory Committee on Evidence Rules, where I have received 25 years of on-the-job training.

Professor Saltzburg: There was no trial advocacy or skills training when I was a law student, so I chose upon graduation to clerk for a federal district court instead of a court of appeals. Back then trials were frequent and I was in court with the judge every other day. Hearing lawyers argue evidence issues and speaking to the judge about his rulings got me really interested in Evidence. So when I joined the University of Virginia faculty, I had no difficulty in choosing Evidence as one of my courses. I have been teaching Evidence since 1972.

M: Can you describe what you believe was at stake for the plaintiffs’ bar in the issue you addressed in Goldman Sachs Group?

Profs: The fraud on the market presumption of reliance is essential to the system of private enforcement of securities laws that we have in the United States. Two key things were at stake in the case: (a) Without the presumption, class securities actions might be doomed, given that individual plaintiffs might have to show that they relied on particular statements or omissions. This would have been difficult and expensive, and courts might have found that a class action was not an appropriate vehicle in securities fraud cases since some plaintiffs might not be able to prove reliance; (b) The position of the defendant – that any evidence offered to rebut the presumption would make the presumption disappear – would have meant that the presumption would be rebutted in almost every case, virtually automatically.

We felt that the evidentiary question in this case was critical to maintaining the fraud on the market presumption and the viability of securities laws.

M: What is the biggest takeaway from the Supreme Court’s Goldman ruling?

Profs: By enforcing a stronger presumption, the Court has signaled that it intends to adhere to the fraud on the market presumption that it established in the Basic case. That is an important signal of the Court’s interest in allowing private causes of action to enforce the securities laws. This was somewhat surprising given the Court’s favorable view of commercial entities in a variety of cases.

M: What was the biggest challenge against the argument made in Pomerantz’s amicus brief?

Profs: The Evidence Rule involved – Rule 301 (“[i]n a civil case, unless a federal statute or these rules provide otherwise, the party against whom a presumption is directed has the burden of producing evidence to rebut the presumption”) – provides that presumptions governed by the Rule are rebutted by a minimal showing (enough for a reasonable person to find that the contrary fact exists). So it was our task to convince the court that the Rule did not apply. The Rule contains an exception for when a federal statute provides otherwise --- but the fraud on the market presumption is not specifically contained in legislation. Rather it is a presumption established by the Court in Basic to promote Congressional intent. So the best argument against our position was that Rule 301, by its terms, governs because the fraud on the market presumption is not found in a federal statute; and the Court rejected that argument.

M: A majority of the Supreme Court agreed with your arguments. What are your thoughts about the dissenting opinion?

Profs: With respect, we believe the dissent incorrectly diminished the holding and meaning of Basic and its progeny. And as to the Evidence question, the dissent read Rule 301 to cover presumptions in a way that would undermine Congressional intent.

M: The Amicus Brief expressed the opinions of 27 of the brightest legal and scholarly minds, including yourselves. How did the 27 of you coordinate your efforts?

Profs: The group of Evidence scholars in the United States is relatively small. At the stage of our careers, everyone knows everyone. If your work is respected, then others in the field will be willing to rely on it --- and, in the case of an amicus brief, to sign on to it. Most of the experts who signed on did so without any suggestions for change. But several of our colleagues provided very helpful suggestions that we implemented. We are extremely grateful to our colleagues who signed on to the brief --- as well as to our counsel, and to Emma Gilmore, without whom the brief would not have been possible.

85 Years - A Wake-Up Call for Boards

POMERANTZ MONITOR | NOVEMBER DECEMBER 2021

By the Editors

In 2013, Russian hackers stole the records of Yahoo’s 3 billion users — including usernames, phone numbers, encrypted passwords and other sensitive information — in what remains, to this day, the largest data breach in U.S. history. In 2014, Russian hackers again compromised the accounts of 500 million Yahoo users. From 2013 through 2015, while Yahoo continued to tout its robust security measures, news of security issues at the company repeatedly surfaced. In 2016, while closing a deal with Verizon, Yahoo finally disclosed the 2014 breach.

Historically, data breach disclosures by publicly traded companies were not generally followed by significant stock price declines, making it difficult to show that investors suffered material harm. With stock prices largely unaffected, cyber-related disclosures, if they engendered any litigation, mainly drove shareholder derivative or consumer protection actions. Data breach securities class actions, when filed, were typically dismissed early on by courts, leaving virtually no precedents.

Pomerantz’s initial investigations revealed a strong indication that Yahoo and its directors had knowingly concealed the company’s deficient security practices and the data breaches of 2013 and 2014. However, the Firm was aware that, given the history of similar litigation, bringing a lawsuit based on such claims was risky. Eager to shape new law, Pomerantz, along with co-counsel, filed a putative securities class action against Yahoo in March 2017.

Jeremy A. Lieberman and Emma Gilmore led Pomerantz’s litigation team. As part of her extensive due diligence, Emma located critical evidence showing that Yahoo’s management had concurrent knowledge of at least one of the data breaches. Importantly, these records showed that Yahoo’s Board of Directors, including Defendant CEO Marissa Mayer, had knowledge of and received repeated updates regarding the breach despite Yahoo denying in its public filings that the CEO knew about the breach. The CEO’s knowledge was a key issue in the case.

The complaint alleged that Yahoo and some of its officers failed to disclose the massive data breaches of 2013 and 2014, as well as two additional data breaches in 2015 and 2016, which affected an additional 32 million Yahoo users. The suit further alleged that defendants knowingly concealed its grossly outdated and substandard information security methods and technologies throughout the class period, while continuing to reassure the public that Yahoo had “physical, electronic, and procedural safeguards that [complied] with federal regulations to protect personal information about [its users],” that it would publicly disclose all security vulnerabilities within 90 days of discovery, and that its data security employed “best practices,” among other misrepresentations.

Beyond the 31 percent decline in share price allegedly suffered by Yahoo’s investors over the course of the class period in reaction to its data breach disclosures, Pomerantz and co-counsel further argued that these data breach disclosures had a substantial and quantifiable financial impact on Yahoo, evidenced when Verizon Communications, Inc. reduced its bid to acquire Yahoo by a whopping $350 million, to $4.4 billion.

After hard-fought litigation, on September 7, 2018, Pomerantz and co-counsel achieved final approval of an $80 million settlement for defrauded Yahoo investors. “While many elements of the Yahoo securities class action may be factually unique,” reported JD Supra’s Carlton Fields and J. Robert MacAneney, “the settlement is a milestone because it is the first significant securities fraud settlement from a cybersecurity breach.”

A month after the class action settlement received preliminary approval from the court, the SEC imposed a $35 million fine on Yahoo in connection with the 2014 data breach, marking the first time a publicly traded company had been fined for a cybersecurity hack. While the SEC acknowledged that large companies are at risk of persistent cyber- related breaches by hackers, it did not excuse companies from reasonably dealing with these risks and of responding to known cyber-breaches. The SEC said that Yahoo continued to mislead investors with generic public disclosures about the risks of cyber-related breaches, when it knew a significant breach had occurred.

Following on the heels of this fine, the SEC updated its guidance on cybersecurity disclosures to stress the importance of cybersecurity policies and procedures and advise companies that they need “disclosure controls and procedures that provide an appropriate method of discerning the impact that such matters may have on the company and its business, financial condition and results of operations.” It also calls for public companies to be more open when disclosing cybersecurity risks, with companies expected “to disclose cybersecurity risks and incidents that are material to investors, including the concomitant financial, legal or reputational consequence.”

Kacy Zurkus, on securityboulevard.com, wrote: Yahoo agreed to settle the securities class action lawsuit to the tune of $80 million, which should serve as a wake-up call for boards. Why? It’s the first of its kind—a milestone shareholder settlement related to a data breach. … [T]here has been little evidence to motivate boards to get started on making real changes—until the Yahoo settlement. The settlement amount—$80 million—is a hefty sum, which makes it much more difficult to ignore the reality that litigation continues to pick up steam.

JD Supra’s Fields and MacAneney presciently concluded at the time that, “Together, the Yahoo proposed settlement and the new SEC guidelines may provide the groundwork that enables plaintiffs’ law firms to bring securities actions to pursue these claims.”

Shareholder Interests Appear to Remain Front and Center in Public Benefit Corporations

POMERANTZ MONITOR | SEPTEMBER OCTOBER 2021

By Brian Calandra

In the wake of the economic downturns following the collapse of the dot-com boom at the turn of the century and the Great Recession of 2008—which were both attributed, in part, to corporate misconduct—legal advocates began exploring alternatives to traditional corporations (“C Corps”) that would prioritize social responsibility and the greater good over short-term profits and share price maximization. These efforts accelerated in 2010, when Maryland became the first state to enact legislation authorizing “public benefit corporations” (“PBCs”). Since then, more than 35 states and the District of Columbia have enacted laws authorizing PBCs, which are for-profit corporations whose boards of directors are required to consider both public benefit and financial performance when making decisions.

While thousands of private PBCs quickly formed in response to these laws, it was not until 2017 that a PBC launched an IPO in the United States. After a short pause, at least nine more PBCs launched IPOs in 2020 and 2021, and, in January 2021, a public C Corp converted to a PBC for the first time. It most likely will not be the last time a C Corp converts to a PBC, as in the past year shareholders of at least 16 public C Corps (including Alphabet, Amazon, Facebook, and Wells Fargo) have submitted proposals to convert those companies to PBCs.

PBCs, and the laws enabling their existence, hope to incentivize socially responsible—or, more precisely, socially cognizant—decision-making by requiring their officers and directors to consider the interests of both the corporation’s shareholders and stakeholders, e.g., employees, customers, members of the community at large, and the environment, over short-term profits.

While these “dual priorities” of PBCs may appear to conflict with, or at the very least diminish, shareholders’ interests, upon closer examination, shareholders’ position at the focal point of corporate activity likely remains undisturbed.

What is a PBC?

Three factors distinguish a PBC from a C Corp. First, the PBC’s corporate purpose stated in its formation documents must include a “social mission.” Second, as described above, PBC directors must consider the impact of the company’s actions on shareholders as well as stakeholders. Third, PBCs must report on their pursuit of their social mission.

Although these elements are generally consistent across PBC statutes, their particulars can vary widely from state to state. For example, while some states require a primary corporate purpose of creating some public benefit, in Delaware, PBCs need only identify public benefits that are among their purposes. In addition, while PBC statutes generally require directors to consider non-shareholder stakeholders when making decisions, these statutes neither identify stakeholders nor assign levels of importance to different types of stakeholders. Finally, some states require PBCs to publicly report on their pursuit of their public benefits while other states only require these reports to be distributed to shareholders.

At its core, incorporating as a PBC ostensibly protects the company’s directors by giving them the flexibility to consider stakeholders without breaching their fiduciary duties to shareholders. For example, a PBC’s board, as opposed to a C Corp’s board, can reject a substantially larger offer from a potential acquirer if the board determines that accepting the offer would undermine the public benefit defined in the PBC’s formation documents. On its face, this act would appear to conflict with shareholders’ interests, since it would seem to be in the shareholders’ interest for any acquisition to occur at the highest possible price. As we will see, however, such an act most likely would be exactly what the PBC’s shareholders wanted the board to do.

Do the Dual Priorities of PBCs Conflict with Shareholders’ Best Interests?

Whether a board has a legal duty to maximize its shareholder value (i.e., a company’s share price) has been and continues to be vigorously debated. Setting aside whether this duty exists, PBCs do not appear to conflict with shareholders’ interests, even if certain actions may not maximize a PBC’s share price.

For example, although a PBC’s directors can consider other stakeholders when making corporate decisions, ultimate corporate authority is still vested squarely with shareholders. If shareholders are unsatisfied with a director’s performance, they have the right to remove that director. Indeed, since the 1990s, rules and regulations have been enacted or revised to make it easier for shareholders to act if they are unsatisfied with a board’s decisions. Rule 14-8 of the Securities and Exchange Act of 1934, which was adopted in 1992, made it easier for shareholders to include their own proposals in proxy statements, and New York Stock Exchange Rule 452, which was enacted in 2010, prohibits brokers from voting in director elections when they have not received instructions from their customers. Since brokers traditionally voted such shares in accordance with current management’s proposals, removing these votes makes it much easier to reject management proposals.

In addition, many PBC statutes expressly provide for “enforcement proceedings” that can be brought when a company fails to pursue its stated public benefit or if the company violates a provision of benefit corporation law. These statutes, however, solely vest the right to bring such enforcement proceedings with shareholders, not the stakeholders.

Further, laws governing PBCs maintain all the rights vested in shareholders of traditional C Corps, including voting on major transactions, inspecting books and records, and filing derivative suits. In short, nothing in the formation of government of a PBC displaces shareholders from their perch atop the corporate hierarchy.

Beyond this undisturbed vesting of authority within shareholders, however, other factors strongly suggest that a PBC will act in its shareholders’ interests. PBCs, which are formed expressly for the purpose of pursuing, and hopefully achieving, some social good, wear their proverbial hearts on their sleeves by enshrining these purposes in their foundational documents and, in the case of publicly traded PBCs, using “Risk Factors” in quarterly and annual reports to expressly warn investors that corporate decision-making may not be based solely on creating profits. Accordingly, an investor in a PBC decides to invest in substantial part because of the PBC’s commitment to a particular social good at the expense of profits, and thus a PBC’s board furthers shareholders’ interests by prioritizing social good over short-term profits or share price.

In addition, a company that incorporates as a PBC should be able to (i) recruit employees who identify with its social mission and who will thus be more productive and loyal, (ii) motivate existing employees who share those values, and (iii) attract business from customers who share those values. Increasing employee productivity and customer loyalty is obviously in shareholders’ best interests because it will make the company’s performance more consistent over the long term.

While these and other arguments show how the PBC form is designed to incentivize corporate conduct consistent with shareholders’ interests, arguments that PBCs conflict with such interests tend to arise from assuming the worst in people—in this case, corporate officers and directors. For example, one common argument expressed by Frank H. Easterbrook and Daniel R. Fischel in The Economic Structure of Corporate Law asserts that officers and directors of a PBC cannot act in shareholders’ best interests because “a manager told to serve two masters (a little for the equity holders, a little for the community) has been freed of both and is answerable to neither.” Another argument asserts that directors and officers will instantly prioritize their own personal interests over shareholders’ and stakeholders’ interests at the first sight of any weakening of their fiduciary duties to shareholders. This is because, the argument goes, there is no effective means to hold the officers and directors legally accountable given that shareholders’ class actions and derivative lawsuits can be batted away by attributing any decision, no matter how irrational, to the pursuit of a vaguely defined social benefit, and stakeholders have no ability to sue under any circumstances.

Conclusion

While it appears that shareholders continue to reign supreme even in PBCs, this new corporate structure has not been around long enough to generate a performance track record or to be tested by proxy battles, derivative lawsuits, and securities fraud class actions. Dueling arguments that they advance or undermine shareholders’ interests are thus only based on theoretical deductions, not hard evidence. Once data on financial performance has accrued and a representative sample of challenges to decision-making have succeeded or failed, it will be time to take stock of whether PBCs are an advance in corporate evolution or a harbinger of doom.

SEC Resets 'Set It and Forget It' 10b5 Plans

POMERANTZ MONITOR | SEPTEMBER OCTOBER 2021

By Jessica N. Dell

On September 9th, the U.S. Securities and Exchange Commission’s (“SEC”) Investor Advisory Committee (“IAC”) adopted new proposed recommendations to overhaul Rule 10b5-1, which the SEC first adopted in 2000 as a framework for insiders of publicly traded corporations to buy and sell securities without running afoul of insider trading laws, compliance rules or the appearance of conflicts of interest, and to set up a trading plan for selling stock they own. Rule 10b5-1 is a clarification of Rule 10b-5, created in 1942 under the Securities and Exchange Act of 1934 in order to explicitly prohibit the use of fraud or deception in connection to the sale or purchase of securities on U.S. exchanges.

Under the terms of Rule 10b5-1, both the seller and the broker making the sales must not have access to any material nonpublic information (“MNPI”). The SEC considers a stock transaction to have been made “on the basis of” MNPI if the trader was “aware” of the MNPI at the time of the transaction. But it also provides an affirmative defense if the transaction was made pursuant to a trading plan that satisfies these conditions: (i) it was adopted in good faith before the insider became aware of MNPI; (ii) it specifies the amount, price, and date of the transactions; (iii) it provides written instructions or a formula that triggers the transactions; and (iv) it does not allow the insider to influence how, when, or whether transactions take place once the plan is established.

Addressing concerns that SEC Chair Gary Gensler first raised in comments to the Wall Street Journal in June, the proposed recommendations seek to “freshen up” Rule 10b5-1, with the goal to reduce the risk that company executives, using private information to opportunistically sell shares of companies they oversee, could invoke this rule as a shield against charges of insider trading. Certain features had “led to real cracks in our insider trading regime,” according to Gensler, and it would be a top priority of the SEC to move quickly to tighten regulations against insider trading.

While the protective trading structure offered to executives under 10b5-1 could continue to meet the intended purpose for good faith transactions, critics pointed to data showing the plans were being used to shield abuse. A 2020 Stanford University study had detailed trends suggestive of abuse, flagging problems with their structure that would continue to frustrate the purpose of these accounts. Calling it a matter of “good corporate hygiene,” the prior SEC Chairman, Jay Clayton, also called for these changes in order to eliminate “any suggestion of impropriety or unfairness.”

Compliance with these plan terms seemed straightforward. To qualify for protection under Rule 10b5-1, executives would enter into a nonbinding contract with a broker third party to execute trades on their behalf and have a “Set it and Forget it” schedule of trades. However, while the expectation was that the executive would rely on Rule 10b5-1 to sell in multiple transactions spread out over time, the reality was starkly different. Because the original rule did not specify a minimum number of transactions, executives could use a newly minted plan for a single trade, as needed. They could have as many plans as they desired to deal on new information and could terminate or modify these at will.

Stanford University’s Rock Center for Corporate Governance, in the aforementioned study, reported that their review of a dataset of over twenty thousand 10b5- 1 plans revealed that “a subset of executives use 10b5- 1 plans to engage in opportunistic, large-scale selling of company shares.” The report described major “red flags ... suggestive of potential abuse” while stating that their findings were also consistent with prior research that suggested “10b5-1 sales systematically precede periods of underperformance and early termination of planned sales systematically precede periods of outperformance.” These trends were suggestive that Rule 10b5-1 plans were being exploited to shield insider trading.

Following Gensler’s directive, a subcommittee of the IAC issued draft recommendations in August. Stating that there was “strong bipartisan support” for revisions to Rule 10b5-1 to “improve transparency regarding insider trades and enable effective investigation and enforcement of violations,” the IAC recommended that the SEC “move quickly to close identified gaps in the current rule.” Among other policy changes, the IAC recommended that insiders or issuers be prevented from having more than one 10b5-1 plan in effect at the same time and would require a cooling-off period from the time of origination or modification.

Under the proposal, executives creating a new 10b5-1 plan or modifying an existing plan would have to endure a “cooling-off” period of at least four months before making trades under the newly adopted or modified plan. The IAC noted that such a cooling-off period would ensure that an insider or issuer could not put in place a plan that trades in the same quarter as its adoption and that limiting the affirmative defense protections to a single plan “would signal to the market that a plan was entered into in good faith.”

The recommended policy also set out additional disclosure requirements including proxy statement disclosure of the number of shares covered under corporate 10b5-1 plans for each executive as well as disclosure (on Form 8K) of the adoption, modification, or cancellation of 10b5-1 plans by an issuer, noting the number of shares covered by such plans. The new rules also extend Form 4 (Statement of Changes in Beneficial Ownership) reporting requirements to all companies – including non-U.S. issuers – with any securities listed on a U.S. exchange.

Approving the IAC’s recommendations in September, Gensler applauded the fast work of the subcommittee, stating “I believe plans under Exchange Act Rule 10b5- 1 have exposed potential gaps in our insider trading enforcement regime…you’ve pointed out some important areas that are in line with what I’ve asked staff to consider in a proposed rulemaking.”

Jennifer Pafiti Honored with 2021 Women, Influence & Power in Law Award

Jennifer Pafiti Honored with 2021 Women, Influence & Power in Law Award Corporate Counsel magazine honored Jennifer Pafiti, Pomerantz’s Partner and Head of Client Services, with a 2021 Women, Influence & Power in Law award for Collaborative Leadership. The awards recognize attorneys — general counsel, in-house leaders and law firm partners — who have “demonstrated a commitment to advancing the empowerment of women in law.” Dedicated to honoring women who champion other women and promote diversity in the legal industry, the WIPL award winners are “business strategists, complex problem-solvers and, of course, great lawyers.”

As a key player in Pomerantz’s litigation against Brazilian oil giant, Petróleo Brasileiro S.A.–Petrobras, Jennifer — along with a litigation team that was 80% female — helped secure a record-breaking $3 billion settlement on behalf of defrauded investors. The culmination of over three years of hard-fought litigation led by Managing Partner Jeremy Lieberman, this significant 2018 victory set records as the largest securities class action settlement in a decade, the largest settlement ever in a class action involving a foreign issuer, and the fifth-largest class action settlement ever achieved in the United States. It is also the largest settlement ever achieved by a foreign lead plaintiff, and the largest class action settlement in history not involving a restatement of financial reports.

Universities Superannuation Scheme (“USS”), the trustee of the UK’s largest private pension scheme as measured by assets, served as lead plaintiff for the class in Petrobras. As an attorney dually qualified to practice law in the US and the UK, Jennifer worked closely with USS throughout the litigation.

While pursuing complex securities fraud litigation, Jennifer also spearheads client development and oversees PomTrack®, a proprietary system for monitoring clients’ assets with state-of-the-art technology and a team of professionals who cross-reference trading data against current and potential securities class action claims.

PomTrack® enables the Firm to alert fiduciaries when assets they oversee suffer significant losses that may be attributable to financial misconduct. Jennifer brought in Pomerantz’s first portfolio monitoring clients from the UK, Germany, and the Netherlands, growing the Firm’s foreign and domestic client base to include some of the most influential institutional investors around the globe. Under her supervision, PomTrack® assets under management have tripled, currently at $6.8 trillion in combined client assets. More than 50% of Jennifer’s PomTrack® team are women and minorities.

Jennifer also leads the Firm’s institutional investor educational initiatives, organizing Pomerantz-sponsored conferences around the world. In 2018, Jennifer organized a Corporate Governance and Securities Litigation conference in New York on the theme of how corporations, law firms, government agencies and pension funds might help women and minorities rise through the ranks and pioneer a path for change and unity in our communities. She is also managing Pomerantz’s upcoming Corporate Governance roundtable, which, after several COVID-related postponements, will take place in California on June 14, 2022, featuring special guest speaker President Bill Clinton.

“There is nothing new about mentoring colleagues while empowering their inclusion and growth in the process,” according to Jennifer. “This has been the status quo for men since time immemorial. What’s new is that public sentiment and the number of women in power in the legal industry have both reached a scale where meaningful gains in equity and inclusion for women will no longer be denied. We owe a responsibility to each other and those who have come before us to help our generation push the tipping point over the edge. This is the moment for women to exert their influence and power.”

Jennifer and her fellow honorees will be recognized at an awards ceremony in October 2021 as part of Corporate Counsel’s Women, Influence & Power in Law Conference in Washington, D.C.

Q&A: Natalie Tuck

POMERANTZ MONITOR | SEPTEMBER OCTOBER 2021

By The Editors

The Monitor recently spoke with Natalie Tuck, Editor of European Pensions, a highly authoritative information source for pension decision makers.

Monitor: What are some of the major hurdles facing European pension schemes today?

Natalie Tuck: The sustainability of pension systems, amid Europe’s ageing population, is a major challenge across the continent. According to data from Eurostat, in 2020 the percentage of those aged over 65 was 20.6%, an increase of 3 percentage points since 2010. This will only increase over the coming years, putting added pressure on public pension systems. Institutions for Occupational Retirement Provision (IORP) schemes are seen as one solution to ease some of that pressure. Defined benefit occupational schemes have their own funding problems, which is why we are seeing a gradual transfer to defined contribution systems in Europe – the Netherlands is in the process of transitioning. However, this passes the burden of sustainability onto individuals, who now need to make sure they save enough for retirement – yet another problem for the industry to solve!

M: What are the current hot topics in regulatory and legislative issues?

NT: Sustainable finance is a key policy area for the European Union and, as a result, it has introduced a package of legislative measures to achieve its objectives. In July this year, the European Commission published its new Sustainable Finance Strategy, which includes several proposals that will impact the pensions industry. For example, it detailed proposals to develop reporting obligations under the Sustainable Finance Disclosure Regulation (SFDR), a regulation that applies to IORPs, to include more reporting on the decarbonization of financial products and social factors. The Commission also proposed changing the prudent person rule under the key pension legislation, the IORP II Directive, to require pension funds to consider participants’ sustainability preferences in investment decisions. In addition, the Commission may make it mandatory for pension schemes to consider the non-financial impact of investment decisions on ESG factors. While the industry is largely supportive of the changes, the industry association, PensionsEurope, is calling for proportionality in the Commission’s approach to IORPs, which greatly vary in size.

M: How does cross-border pension pooling work?

NT: Pension funds have several options when it comes to cross-border pension pooling. They can create their own cross-border IORP scheme, join a cross-border master trust, or companies can pool their pension fund assets through common investment funds. The first two are facilitated through the IORP II Directive introduced in 2016 but have actually been possible since 2003, when the first IORP Directive was introduced. These schemes, which can be defined benefit or defined contribution, must comply with the local social and labor laws, and taxation rules, of the country they are offered in. For example, if a cross-border fund is based in country A (home state), but operates in countries B, C and D, it would be necessary to create specific national compartments complying with the local laws and rules of each country. The latter option of pooling assets through common investment funds, is more of a lite touch option to pension pooling. In this case, companies have the option to invest assets from their pension schemes in different countries alongside each other in a common investment fund. There are several tax transparent vehicles that can be used, such as Ireland’s Common Contractual Fund (CCF) or the Luxembourg domiciled Fonds Common de Placement (FCP), among others.

M: How do European pension funds see litigation as a vehicle for asset recovery after incidents of securities fraud?

NT: European pension funds are increasingly turning to the law as a way to recover assets lost due to securities fraud. Your own Managing Partner, Jeremy Lieberman, recently explained in a podcast with European Pensions, that having watched their US counterparts receive compensation whilst they suffered only losses, European pension funds realized that engaging with companies on this wasn’t working. To quote Jeremy, whilst many European institutional investors “don’t want to put their head above the parapet,” that attitude is now changing, driven by the necessity to recover financial losses. There’s also strength in numbers, and many pension funds are joining class actions and multi-claimant cases, and in some instances, acting as the lead plaintiff.

M: What is the most significant story that you have covered so far on the pension beat?

NT: The introduction of the freedom and choice pension reform in the UK market, which was introduced in April 2015. It was a huge shock to the industry when it was announced by then Chancellor George Osborne in March 2014, as there had been no leaks about it beforehand. The industry was given one year to prepare for the changes, which completely revolutionized the decumulation market in the country. Savers went from, in most cases, having to purchase an annuity upon retirement, to having the freedom to choose between an annuity, drawdown or to take all their cash at once.

M: How do ESG and equity inclusion for women and minorities rank as concerns for European pension funds?

NT: Pension funds in the Nordics lead the way when it comes to ESG considerations, with many now publishing sustainability reports alongside their annual reports detailing the work they do in this area. However, a lot of the focus is on the ‘E’ (environmental) part of ESG and although progress is being made on the equity of women, there is still a long way to go. That being said, I have noticed the issue rising up the agenda, from pension funds pushing for greater female board representation within their investee companies to looking at ways to close the gender pension gap that so often affects their own scheme members.

M: What inspires you most in your work each day?

NT: One of the reasons I became a journalist is because I get to do something different, learn something new and speak to different people every day. As a pensions journalist I’m fortunate to write on a hugely diverse topic; one day I could be covering class actions, or ESG investment topics, and the next I might be writing about diversity or pensions inadequacy. I’m particularly inspired by the passion of those working in the pensions industry, who strive for the best outcomes for pensions scheme members.

M: Arsenal or Manchester United?

NT: Manchester United – hopefully we will be in with a chance now that Cristiano Ronaldo has returned to Old Trafford.

85 Years - Clearing the Air About Discovery

BY THE EDITORS

In Fiat Chrysler, Pomerantz increased the discovery tools available to investors litigating against highly regulated companies

In September 2015, Pomerantz filed a complaint against Fiat Chrysler Automobiles N.V., one of the world’s largest car manufacturers, on behalf of a retail investor. After years of hard-fought litigation, in late 2019, the Firm achieved a $110 million settlement for defrauded investors, representing between 13.75% and 19% of maximum recoverable damages – an exceptionally high percentage for this type of action. In addition to the substantial financial recovery, Pomerantz set important precedent that expanded shareholder rights, while significantly advancing the ability of investors to obtain critically important discovery from regulators that are often at the center of securities actions.

The complaint alleged that defendants misled investors by asserting that the company was complying with regulations for conducting safety recalls set by the National Highway Traffic Safety Administration (“NHTSA”), and with regulations for controlling emissions of Nitrogen Oxide (“NOx”) set by the Environmental Protection Agency (“EPA”) and the European Union. Fiat Chrysler, in fact, had been violating those regulations since 2013 – it purposefully delayed notifying vehicle owners of defects and failed to repair the defects for months or years. More nefariously, the company also installed “defeat device” software in its diesel vehicles, designed to detect when the vehicle was being tested by a regulator such as the EPA. When testing conditions were detected, the vehicle would perform in a compliant manner, limiting emissions of NOx. When testing conditions were not detected, such as during real-world driving conditions, the emissions controls were disabled, and the vehicles would spew illegal and dangerous levels of NOx.

 On July 26, 2015, the NHTSA fined Fiat Chrysler a record-high $105 million and required a substantial number of recalls and repairs. On October 28, 2015, the company announced a $900 million charge to earnings for an increase in estimated future recalls. The market responded to this news with a nearly 5% drop in the company’s share price, resulting in a $950 million decline in its market capitalization. In 2016 and 2017, when the EPA and other U.S. and European regulators publicly accused Fiat Chrysler of using defeat devices to cheat NOx emissions regulations, the company’s stock price declined further by 5% and 12% respectively.

Discovery in the case was particularly challenging, given the complexity of the emissions software technology, the international nature of the claims, and that the key defendant, Fiat Chrysler CEO and Chairman Sergio Marchionne, was hospitalized (and later died) three days before his scheduled deposition. Additionally, it involved analyzing millions of pages of documents and resulted in the exchange of reports by eleven experts on issues implicating U.S. as well as European regulations.

Pomerantz sought the deposition of a former employee of NHTSA. The United States Department of Transportation (“USDOT”), like most federal agencies, has enacted a set of regulations — known as “Touhy regulations” — governing when its employees may be called by private parties to testify in court. On their face, USDOT’s regulations apply to both current and former employees. Citing these regulations, NHTSA denied Pomerantz’s request to depose a former NHTSA employee who had interacted with Fiat Chrysler. Despite the widespread application of these regulations to former employees, Pomerantz filed an action against USDOT and NHTSA, arguing that Touhy regulations speak only of “employees,” which should be interpreted to apply only to current employees. The court granted summary judgment in favor of Pomerantz’s clients, holding that “USDOT’s Touhy regulations are unlawful to the extent that they apply to former employees.” This victory has greatly shifted the discovery tools available, so that investor plaintiffs in securities class actions against highly regulated entities (for example, companies subject to FDA regulations) may now depose former employees of the regulators to get critical testimony concerning the company’s violations and misdeeds.

The claims ultimately survived multiple rounds of motions to dismiss. Initially, the emissions allegations were dismissed because the court determined that the complaint did not plead facts sufficient to demonstrate that the defendants knew that their statements of compliance were misleading. Given leave to replead, Pomerantz filed Freedom of Information Act (“FOIA”) requests with the EPA, which led to critical new information. Pomerantz successfully argued, in opposition to the defendants’ second motion to dismiss, that emails received by the company’s head of regulatory affairs from the EPA stating that the company may be violating the law were sufficient to plead that the defendants’ subsequent statements of compliance were actionable. Significantly, Pomerantz established that a company professing compliance with regulations must also disclose if their regulators have taken a different position, even if it is not a final determination by the regulator. The additional allegations in Pomerantz’s amended complaint revived the emissions claims. Ultimately, Pomerantz secured class certification on behalf of investors.

At the summary judgment stage, Pomerantz did not merely defend against defendants’ motions, but also affirmatively moved to exclude certain expert testimony proffered by defendants, and for sanctions for spoliation of evidence. As the prospect of trial loomed, defendants finally agreed to settle.

The litigation was led by Pomerantz Partner Michael J. Wernke with Managing Partner Jeremy A. Lieberman. In approving the settlement, the court stated that Pomerantz should view the award of attorneys’ fees “as a substantial compliment for you[r] work … [I]t is most clearly evidenced by the results which were quite impressive on behalf of the class. And needless to say, given my own familiarity with the extensive litigation of the class including the collateral litigation that you had to engage in, I think you’ve done substantially a really terrific job on behalf of the class and really are to be commended.”

SCOTUS Decision Endorses Pomerantz Evidence Standard

POMERANTZ MONITOR | JULY AUGUST 2021

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Plaintiff Takeaways from High Court’s Goldman Ruling

POMERANTZ MONITOR | JULY AUGUST 2021

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The majority retorted:

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

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

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

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

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

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

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

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

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

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

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

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

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