Pomerantz Secures Major Victory for Investors in Case Against Deutsche Bank

POMERANTZ MONITOR | MAY JUNE 2022

By Emma Gilmore

“This case has been particularly meaningful to me, given the misconduct at issue — Deutsche Bank’s lending and servicing of Jeffrey Epstein’s accounts — despite knowledge that he sexually abused at least 40 girls.” — Partner Emma Gilmore

Pomerantz clinched a significant victory for investors in a securities fraud class action brought against Deutsche Bank for its false and misleading representations about the Bank’s Know Your Customer procedures—an important aspect of the Bank’s anti-money-laundering processes. On May 18, 2022, Judge Jed S. Rakoff of the United States District Court for the Southern District of New York denied in large part defendants’ motion to dismiss all claims in Karimi v. Deutsche Bank AG, in which Pomerantz serves as sole Lead Counsel.

The complaint alleges that during the relevant Class Period, Deutsche Bank and several of its executives, including its CEO, made materially false and misleading statements about its anti-money-laundering (“AML”) deficiencies and failed to properly monitor or gave exemptions to customers it considered high risk, such as financier and accused sex offender, Jeffrey Epstein. For example, defendants repeatedly assured investors that Deutsche Bank had “developed effective procedures for assessing clients (Know Your Customer or KYC) and a process for accepting new clients in order to facilitate comprehensive compliance,” and insisted that “[o]ur KYC procedures start with intensive checks before accepting a client and continue in the form of regular reviews.” Defendants also claimed Deutsche Bank’s “robust and strict” KYC program “includes strict identification requirements, name screening procedures and the ongoing monitoring and regular review of all existing business relationships,” with “[s]pecial safeguards… implemented for…politically exposed persons.”

In truth, however, far from implementing a “robust and strict” KYC program with “special safeguards” for politically exposed persons (“PEPs”), during the Class Period, defendants repeatedly exempted high-net-worth individuals and PEPs—including unsavory figures like Jeffrey Epstein and individuals sponsoring terrorism—from any meaningful due diligence, enabling their criminal activities through the use of the Bank’s facilities. That practice commenced with Deutsche Bank’s former CEOs onboarding, retaining and servicing Russian oligarchs and PEPs reportedly engaged in criminal activities.

For example, despite widespread coverage of Epstein’s child sex trafficking and abuse, Deutsche Bank’s executives onboarded Epstein as a client in 2013, enabling his criminal activities to not only continue, but also to flourish. In addition to opening and servicing wealth-management accounts for Epstein, Deutsche Bank also provided loans to Epstein and his businesses. Epstein was onboarded based on the lucrative business he would generate for the bank, with Deutsche Bank estimating “flows of $100-300 [million] overtime [SIC] (possibly more) w/ revenue of $2-4 million annually over time….” Despite knowing that by 2011, “40 underage girls had come forward with testimony of Epstein sexually assaulting them,” Deutsche Bank remained “comfortable with things continuing” with Epstein, “not[ing] a number of sizable deals recently.” One of several confidential witnesses with knowledge of Deutsche Bank’s KYC processes explained that, after Epstein was onboarded, decisions about whether to continue keeping him as a client were repeatedly escalated, including to Deutsche Bank’s Reputational Risk Committee and members of Deutsche Bank’s Executive Committee for the Bank’s Global Wealth Management. Despite these warnings, Deutsche Bank repeatedly approved retaining and servicing Epstein. From the time of Epstein’s onboarding, the relationship was classified by Deutsche Bank as “high-risk” and therefore should have been subject to enhanced due diligence. Instead, in a sordid twist of irony, the Bank designated Epstein an “Honorary PEP.”

Defendants made a number of arguments that Pomerantz defeated. For example, defendants argued that Deutsche Bank’s representations to investors about their Know Your Customer procedures were aspirational and immaterial and that, in any event, the investing public was provided with more than enough information to understand the state of Deutsche Bank’s AML and KYC processes (the so called “truth-on-the-market” defense). Pomerantz successfully countered that defendants’ representations were material to investors because, by exempting PEPs and other high-risk individuals from any meaningful KYC procedures, the risk to the Bank’s reputation and the risks of criminal and civil liability were significantly heightened. The materiality of defendants’ statements was also demonstrated by defendants’ repeated discussion of these topics throughout the Class Period. Pomerantz successfully defeated defendants’ “truth-on-the-market” argument that investors knew Deutsche Bank’s AML procedures were not always effective, explaining that such defense on this record was intensely fact-specific and improperly raised at the motion to dismiss stage, particularly given Deutsche Bank’s affirmative representations of compliance made throughout the Class Period.

Judge Rakoff set a trial date for November 2022.

Partner Emma Gilmore, who leads the litigation, said, in response to Judge Rakoff’s decision, “This case has been particularly meaningful to me, given the misconduct at issue – Deutsche Bank’s lending and servicing of Jeffrey Epstein’s accounts – despite knowledge that he sexually abused at least 40 girls.”

Pomerantz Achieves Victory for Defrauded Chicago Bridge & Iron Investors

POMERANTZ MONITOR | MAY JUNE 2022

By Joshua B. Silverman

In a victory for investors, Pomerantz, as counsel for two of the three court-appointed class representatives, achieved a $44 million settlement in a securities fraud class action against Chicago Bridge & Iron Co., N.V. (“CBI”) and its former Chief Executive Officer, Chief Financial Officer, and Chief Accounting Officer. The Honorable Lorna G. Schofield of the United States District Court for the Southern District of New York granted preliminary approval of the settlement on March 30, 2022 and set the final approval hearing for July 25, 2022.

CBI is an energy services company specializing in the engineering, procurement and construction of energy plants and related facilities. In 2013, CBI entered the nuclear fabrication business by acquiring The Shaw Group for $3.3 billion. The crown jewel of the acquisition was Shaw’s nuclear construction unit, which was part of a consortium building the first new nuclear plants in the United States in decades, two at a Georgia facility called Vogtle and two at the V.C. Summer facility in South Carolina. CBI and its CEO claimed to have conducted thorough due diligence prior to the acquisition and to have gained a clear understanding of the status of the nuclear projects.

Between October 2013 and January 2015, CBI and its executives made several positive but false statements about the progress of the nuclear projects, hid adverse information about schedule delays and cost overruns, and claimed in periodic reports filed with the Securities and Exchange Commission that there were no indicators of impairment despite significant internal red flags indicating that the nuclear projects were unlikely to ever yield the profits that the company had modeled. They also misrepresented CBI’s ability to recover for unapproved change orders (“UCOs”)—massive but disputed invoices for expenses stemming from design changes. Although the electric utilities that owned the nuclear projects and CBI’s consortium partner refused to reimburse CBI for the UCOs, CBI nonetheless told investors that payment was probable and booked them as revenue.

In mid-2014, institutional analyst firm Vertical Research and short seller Prescience Point each put out negative reports about CBI’s nuclear construction business. By early 2015, it was clear to CBI (and increasingly to investors) that the nuclear construction business was a disaster. CBI began to negotiate a “quit claim” deal with its consortium partner, Westinghouse, to essentially walk away from the nuclear construction projects, stemming losses but receiving virtually nothing for the business it had paid billions for just two years earlier. In October 2015, CBI announced that it would transfer the nuclear construction business to Westinghouse for only a true up of expenses incurred during the transition.

Early motion practice wins established a momentum that carried plaintiffs to trial. First, plaintiffs defeated defendants’ attempt to transfer the lawsuit to the Southern District of Texas, where CBI would enjoy a “home court” advantage. Then, plaintiffs defeated defendants’ motions to dismiss.

Years of discovery developed strong evidence that defendants had concealed adverse information about the nuclear projects from investors. Pomerantz and other plaintiffs’ counsel reviewed over 9 million pages of documents and took approximately 30 depositions. They uncovered evidence that CBI had manipulated its financial reporting by mixing the nuclear construction business with other profitable businesses into a single reporting unit to hide deterioration and avoid a write-down, that both the owners and Westinghouse had rejected CBI’s view that the contracts required reimbursement of UCOs, and that CBI internally did not expect to be paid on many items booked as revenue for several years, if ever.

In addition to uncovering strong factual evidence, plaintiffs also put together a world-class slate of expert witnesses on the topics of market efficiency, damages/loss causation, accounting, and materiality. These experts were particularly crucial at class certification, where both sides’ economic experts testified during an eleven-hour hearing before the Special Master appointed by the Court, the Honorable Shira Scheindlin (Ret.). Pomerantz played a key role, cross-examining defendants’ expert and exposing the weaknesses in her price impact analysis. The Special Master ruled in a 107-page Report & Recommendation that certification should be granted, which the District Court adopted. After full briefing, the United States Court of Appeals declined to consider an appeal of that ruling.

Unbowed, and despite the considerable evidentiary record amassed by plaintiffs, defendants moved for summary judgment on all claims. After full briefing, the district court denied that motion and set the case for trial in February 2022.

Trial always involves risks, and this one more so than others. Defendants had won a jury trial of similar claims in Texas state court against a hedge fund that opted out of the class action. Although Pomerantz believed that its case did not suffer from the flaws that sunk the Texas case, the Texas trial showed that the risk of an adverse verdict was substantial. Against these risks, the class action plaintiffs had limited upside to proceeding to trial. The corporate defendant and its parent had both declared bankruptcy, and the individual defendants did not have sufficient resources to satisfy a large jury award. While Pomerantz and other plaintiffs’ counsel retained bankruptcy counsel to make sure that bankruptcy releases did not bar class claims, the bankruptcy effectively meant that recovery was limited to a rapidly eroding insurance stack.

Acknowledging the risks that both sides faced at trial, the parties decided to take a final run at mediation before the Honorable Layn R. Phillips (Ret.). Ultimately, both sides accepted a mediator’s proposal to settle the case for $44 million, an excellent recovery under the circumstances. Despite the bankruptcy, Pomerantz’s perseverance resulted in a class recovery that was significantly higher than the median for comparable class actions.

A Case for Statistical Evidence in Insider Trading Claims

POMERANTZ MONITOR | MAY JUNE 2022

By Dolgora Dorzhieva

Insider trading is tough to prove, and it can take years to gather enough evidence to successfully prosecute it. Preet Bharara, the former U.S. Attorney for the Southern District of New York, has called insider trading, undertaken by company insiders and hedge funds, “rampant.” The SEC has developed data analytics tools to aid the investigation of insider trading cases with statistical evidence. However, in SEC v. Clark and Wright, the court rejected the SEC’s statistical evidence as “just a matter of speculation.” On occasion, evidence of insider trading is used to determine whether scienter exists in Rule 10b-5 or securities fraud cases. This article will describe the value of statistical evidence and explain what steps plaintiffs’ lawyers can take to leverage such evidence in prosecuting insider trading claims.

What is Insider Trading?

Insider trading involves trading in a public company’s stock by someone who has material nonpublic information (“MNPI”) about that stock. MNPI is data relating to a company that has not been made public but would have an impact on its share price when made public. Insider trading is often carried out by a group of people rather than by an individual acting alone. Frequently, the person who receives inside information from within an organization (“a tipper”) does not trade on that information, but rather passes information on to others (“tippees”), who ultimately trade based on that information. This type of insider trading is illegal because insiders cannot “misappropriate” information for their own benefit.

Investors may be deterred from participating in the market if they know that others are trading on nonpublic information. However, insider trading violations are difficult both to prosecute and to prove. Often, defendants in insider trading cases will deny their awareness of MNPI at the time of a securities trade, or defendants will claim that their reason for trading was completely unrelated to the information in their possession. Because insider trading involves secret information and communications, it is rare to find a smoking gun proving that a trader was tipped and by whom (i.e., what they knew, when they knew it, and how they found out). Therefore, the government and the plaintiffs’ bar often rely––at least initially––on circumstantial evidence to draw the strong inference that the defendant was aware of MNPI and used that information for personal profit when trading.

SEC v. Clark and Wright and the SEC’s Data Analytics Tools

To aid the investigation of insider trading cases, the SEC has developed numerous data analytics tools for analyzing massive amounts of data to identify suspicious trading, such as improbably successful trading across different securities over time. In SEC v. Clark and Wright, the SEC argued that the trades in question were suspicious because they had “an improbable success rate.” The SEC alleged that Christopher Clark and his brother-in-law, William Wright, the former controller for CEB, Inc., engaged in insider trading in advance of CEB’s acquisition. Based on the information tipped by Wright, Clark allegedly purchased highly speculative, out-of-the money call options. The SEC further alleged that, after the public announcement of the acquisition of CEB for $2.6 billion, Clark liquidated his CEB options and made a profit of over $240,000. The cornerstone of the SEC’s case was “suspicious trading”: Clark and his son purchased CEB’s highly risky options before the merger announcement after Clark maxed out his family’s credit line, took out a loan on his car and liquidated his wife’s IRA account to finance these trades. According to the SEC, Clark and his son “were the only investors in the entire world willing to buy such risky options” and accounted for 100% of the buy-side volume on the days in question. The SEC took the position that Clark’s too-good-to-be-true trades, combined with the fact that Clark borrowed money to make the trades, spent ample time with Wright, and traded after communicating with Wright, clearly pointed to insider trading. Instead of initially presenting testimony or other direct evidence, which is hard to obtain at the outset of insider trading cases, the SEC’s case largely hinged on its statistical surveillance tools’ identification of the trades as “highly suspicious.

Wright settled with the SEC in October 2021. Clark proceeded to trial. Courts have repeatedly held that evidence of suspicious trading that coincides with communications between the alleged tippee and tipper should go to the jury. Judge Hilton, however, ended the SEC’s trial against Clark without hearing Clark’s arguments or allowing the jury to weigh in, finding that the SEC’s statistical evidence was “just a matter of speculation” and that the “improbable success rate” of Clark’s trades was not evidence of anything at all: “the government can speculate that he made a little too much money, he was a little successful or more successful than he ought to be, so therefore he’s getting insider information, but there’s no evidence of it.” Judge Hilton added that “[t]here’s just simply no circumstantial evidence here that gives rise to an inference that he received the insider information.”

The Role of Statistical Evidence in Civil Cases

Is there a qualitative distinction between statistical and non-statistical evidence? According to Judge Posner, “[t]he probabilities that are derived from statistical studies are no less reliable in general than the probabilities that are derived from direct observation, from intuition, or from case studies of a single person or event.” The ambiguity of “statistical” evidence does not differ in kind from the ambiguity of “non-statistical” evidence. The “real problem” of statistical evidence is not the explicit characteristics of the evidence itself; it is instead the interpretation given to that evidence. At its core, evidence takes on meaning for trials only through the process of being considered by an individual. And Judge Hilton’s interpretation of the SEC’s statistical evidence of “suspicious trading” could have been very different from the jury’s interpretation of the same evidence. Moreover, while the use of statistical analysis to identify insider trading is novel, the use of statistical analysis in other fields to provide legal proof is not. Many courts have permitted proof of causation through statistically-based evidence in toxic tort cases, even when the evidence is thin and attenuated, and stronger and better evidence is unavailable. The courts and regulators also rely on statistical analysis to help prove systemic employment discrimination and the efficacy of treatments in clinical trials. This is because the approach employed in statistical analysis of arriving at a conclusion by ruling out plausible alternative explanations is consistent with judicial fact-finding.

The SEC has been very successful in litigating insider trading claims solely on the basis of statistical evidence. For example, in SEC v. Ieremenko, et. al., a case brought against a hacker and several traders who traded on nonpublic information stolen from the SEC’s EDGAR database, the SEC successfully argued that the defendants’ trading was correlated with the EDGAR hacks: “[i]t is virtually impossible that [the suspicious trading] could have occurred by random chance. Statistical analysis shows that for each of the Trader Defendants, the odds of that trader trading so disproportionately in hacked events by random chance ranged from less than 7 in 10 million to less than 1 in 1 trillion. This means that for each of the Trader Defendants, it is nearly impossible that their trading is uncorrelated with the hack of the EDGAR system.”

Thus, it is surprising that the SEC’s case against Clark was dismissed so early. The SEC appealed and, if it prevails, the ultimate legal impact of Judge Hilton’s outlier decision should be minimal. Judge Hilton did not give the SEC a chance to establish evidence of scienter based on strong circumstantial statistical evidence.

An Expert’s Advice for the Plaintiffs’ Bar for Successful Prosecution of Insider Trading Claims

What steps can plaintiffs’ lawyers take to leverage the value of statistical evidence in identifying and deterring wrongdoing in insider trading cases? To find out, I interviewed Daniel Taylor, a professor at The Wharton School of the University of Pennsylvania, who leads the Wharton Forensic Analytics Lab and has done extensive research on insider trading. According to Taylor, a weakness of the plaintiffs’ bar is that it tends to rely on experts who are credentialed law professors not trained in data analysis and visualization. Lawyers don’t understand the power of data and often do not know how to convincingly present statistical evidence to a fact-finder. Taylor says that the plaintiffs’ bar needs a broader expert network for insider trading that includes experts in data analysis and the tools for presenting that analysis to laymen, such as charts and graphs. According to Taylor, there is a lack of visualization within many legal briefs that allege suspicious trading. Taylor says that in an insider trading case, persuasive and compelling evidence would consist of probability calculations and an analysis of counter-factuals. For example, one can highlight an extreme outlier trade by comparing the trade to the distribution of normal trades. Another helpful technique would be to explain the counter-factual: for example, as it was with Clark, it is exceptionally rare for an individual to liquidate their retirement accounts, max out their credit lines, take out an auto loan, and risk those proceeds investing in out-of-the-money options unless the individual knew they had MNPI.

COVID-19 and the Litigation Pandemic

POMERANTZ MONITOR | MAY JUNE 2022

By The Editors

In January 2020, as the novel coronavirus spread globally and the death toll rose, so too did peoples’ fears. While many companies diligently shared information about their new risks with shareholders, others sought to profit from the widespread anxiety. On March 12, 2020, one day after the World Health Organization declared the novel coronavirus to be a pandemic, the first COVID-19-related securities class action lawsuits were filed. Each of these litigations is representative of a separate trend in subsequent securities class actions related to COVID-19: cases that target industries, such as pharmaceuticals, whose products are involved in responding to the coronavirus, and cases that target industries that the virus directly affected, such as cruise lines.

One of the two securities class actions filed on March 12, 2020, targeted Inovio Pharmaceuticals, Inc. (“Inovio”) and its CEO, J. Joseph Kim. Kim, in two public appearances in February 2020 – one on Fox Business News and one with President Trump – claimed that Inovio had already developed a COVID-19 vaccine and would start phase one testing in the early summer. Inovio’s stock price skyrocketed amidst a buying frenzy – that is, until Citron Research disclosed that Inovio did not, in fact, have a viable vaccine. Subsequently, the company was forced to acknowledge that it had merely “designed” one. According to the complaint, that disclosure led to a two-day drop in Inovio’s share price that “wiped out approximately $643 million in market capitalization for the Company, marking a 71% decline from its Class Period high.”

The second COVID-19-related securities action filed on that day sued Norwegian Cruise Line Holdings (“NCL”) on behalf of a proposed class of shareholders who had purchased shares of the company during the three weeks before the pandemic was declared. On February 20, 2020, NCL issued a press release stating that “despite the current known impact” from the coronavirus outbreak, as of the week ending February 14, 2020, “the Company’s booked position remained ahead of prior year and at higher prices on a comparable basis.” In other words, they had plenty of ticketed passengers and NCL was still planning on setting sail with them. It further stated that the company “has an exemplary track record of demonstrating its resilience in challenging environments” and that NCL had “proactively implemented several preventive measures to reduce potential exposure and transmission of COVID-19.”

The complaint alleged that these statements, as well as others in the company’s SEC filings published concurrently with the press release, were false and misleading. The complaint quoted a Miami New Times article that reported that leaked internal NCL emails demonstrated that the company had pressured its sales teams to mislead customers about the coronavirus and to respond to customers’ concerns by suggesting, among other things, that the virus could not survive in warm Caribbean climates. The article further reported that while news of the coronavirus was dramatically reducing cruise bookings, management was “trying to downplay the disruption in sales at all costs.”

The Securities and Exchange Commission (“SEC”) gave initial COVID-19 guidance to companies when, on April 8, 2020, its Chairman, Jay Clayton, and Director, Division of Corporation Finance, William Hinman, issued a joint statement titled “For Investors, Markets and Our Fight Against COVID-19.” They stated that company disclosures should “respond to investor interest in: (1) where the company stands today, operationally and financially, (2) how the company’s COVID-19 response, including its efforts to protect the health and well-being of its workforce and its customers, is progressing, and (3) how its operations and financial condition may change as all our efforts to fight COVID-19 progress. Historical information may be relatively less significant.”

Inovio and Norwegian Cruise Line: The Rulings

In February 2021, the court largely upheld the Inovio plaintiffs’ claims described above; the case is ongoing.

As for Norwegian Cruise Line, on April 10, 2021, Judge Robert N. Scola, Jr. of the Southern District of Florida granted NCL’s motion to dismiss with prejudice. As Kevin M. LaCroix posted on the D&O Diary on April 12, 2021 “Judge Scola seemed comprehensively skeptical of the plaintiff’s case.” The judge held that the statements at issue were protected by the “safe harbor” provision for forward-looking statements of the Private Securities Litigation Reform Act of 1995. This provision encourages companies to provide projections of future financial results and other forward-looking statements, so long as such statements are identified as forward-looking and accompanied by strong cautionary disclosure about factors that could cause actual results to differ materially from those disclosed in the statements.

Judge Scola also held that, as to the alleged marketing scheme to downplay the impact of the coronavirus, plaintiff made the assumption “that at the time these statements were made, the statements were false,” but the Judge wrote that “it is worth noting that at the time the alleged marketing scheme was taking place, then-President Trump made similar statements regarding COVID-19 and therefore it is arguable that these statements were not even deceptive, insofar as they aligned with the pronouncements of our nation’s President.”

Lest some are tempted to speculate on Judge Scola’s political leanings, given his reliance on President Trump as an arbiter of truth, the Monitor would like to point out that the judge was appointed by President Obama.

The Trajectory: Then to Now

Early COVID-related securities actions focused on companies that relied on misrepresentation to increase share price and insufficient risk disclosures prior to the pandemic. Years later, these continue to be central to many complaints. The initial cases primarily targeted companies that the virus directly impacted, such as pharmaceutical companies and cruise lines. As allegations broadened to include challenges to companies’ representations about how the pandemic impacted projections of future financial performance and consumer behavior, so too, the types of industries targeted by securities lawsuits expanded. Technology companies, manufacturers of pandemic-related products, travel companies, finance, utility, and social media companies have all been sued for violations of the federal securities laws. The Securities and Exchange Commission (“SEC”) has stepped in to address COVID-19 related fraud with enforcement actions. Derivative cases stemming from COVID-19 securities class actions have been filed against directors of corporations for inadequately fulfilling their fiduciary duties during the pandemic.

On January 26, 2022, Pomerantz was appointed co-lead counsel in a putative securities class action lawsuit against biotechnology company, Novavax, Inc., arising from Novavax’s statements made in connection with its failed attempt to bring its COVID-19 vaccine candidate, NVX-CoV2373, to market. Plaintiffs allege that Novavax misled investors about the vaccine’s purported successful development, production, and imminent approval by the U.S. Food and Drug Administration (“FDA”). “In reality,” according to the complaint, “Novavax’s vaccine was nowhere close to being approved for use: (a) because the vaccine’s purity and potency numbers fell well below FDA safety requirements as a result of severe manufacturing problems including several undisclosed contamination events at its two U.S. manufacturing facilities; (b) because of a failure to manufacture the vaccine at scale; and (c) because of supply chain disruptions—all of which caused significant delays that jeopardized any chance Novavax had to capitalize on the market for Covid-19 vaccines.”

A series of partial disclosures, beginning on May 10, 2021, revealed problems with NVX-CoV2373, including manufacturing issues and delays with its application for Emergency Use Authorization from the FDA. Finally, on October 19, 2021, Politico published an article entitled “They rushed the process: Vaccine maker’s woes hamper global inoculation campaign.” The article reported that Novavax “faces significant hurdles in proving it can manufacture a shot that meets regulators’ quality standards” with respect to NVXCoV2373” and cited anonymous sources as stating that Novavax’s “issues are more concerning than previously understood” and that the company could take until the end of 2022 to resolve its manufacturing issues and win regulatory authorizations and approvals.

Pomerantz is vigorously fighting to vindicate defrauded Novavax shareholders’ rights and recover their losses caused by fraud.

The Fourth Circuit Raises the Bar for Plaintiffs Pleading Scienter

POMERANTZ MONITOR | MAY JUNE 2022

By Christopher Tourek

A core pillar in many securities’ fraud actions is scienter – i.e., whether a defendant acted with an intent to deceive, manipulate, defraud, or was severely reckless, which is defined as carelessness so unreasonable that it risked misleading shareholders. To make it past the motion to dismiss stage, plaintiffs are required to allege sufficient facts to establish that the likelihood of fraudulent intent – the inference of scienter – is at least as strong as the likelihood of any non-fraudulent explanation for a defendant’s actions. The Court of Appeals for the Fourth Circuit recently addressed the issue of which elements must be pled to establish scienter in a securities fraud case and, in doing so, highlighted the uphill battle that plaintiffs face in sufficiently pleading scienter to survive a motion to dismiss.

As set forth in In re DXC Technology Company Securities Litigation, DXC issued a press release touting its financial success, but months later, the company revised its projected revenue downward by approximately $800 million, causing the company’s share price to drop. Plaintiffs subsequently brought suit against DXC and its executives, alleging that they knew, contrary to DXC’s press release, that cost-cutting measures in 2018 would impede the company’s ability to draw revenue. The District Court for the Eastern District of Virginia dismissed the complaint, and the plaintiffs appealed that decision to the Court of Appeals for the Fourth Circuit.

The Fourth Circuit affirmed the District Court’s dismissal of the stockholders’ claim of securities fraud and, in doing so, analyzed the five different categories of scienter that the plaintiffs relied upon. Specifically, to determine whether the requisite scienter existed, the Fourth Circuit analyzed (1) statements of unnamed former employees, (2) the core-operations theory, (3) allegations by a former executive, (4) stock sales made by the defendants, and (5) the temporal proximity between the defendants’ optimistic statements and the ultimate admission of disappointing revenue. In ruling against the plaintiffs, the Fourth Circuit discounted most of the plaintiffs’ allegations on which they premised scienter and, in doing so, emphasized the high bar that plaintiffs must meet to make it past a defendant’s motion to dismiss.

The Fourth Circuit first reviewed the statements of unnamed former employees to the effect that they were concerned about the cost-cutting measures. There, the Fourth Circuit found that, by and large, the former employees had little or no contact with the defendants and did not pass along their concerns to the defendants. This, combined with the fact that the few times employees did notify the defendants of their concerns were described by the complaint in a vague and conclusory fashion, led the Fourth Circuit to discount this factor. Thus, plaintiffs who rely on statements of former employees in the future will need to make sure that those employees had direct contact with the defendants and describe those interactions with particularity.

Similarly, the Fourth Circuit discounted the plaintiffs’ core operations theory because, as with the statements of former employees, the complaint lacked “particularized allegations” regarding the defendants’ knowledge of the shortcomings due to the cost-cutting measures.

The Fourth Circuit also analyzed the plaintiffs’ claims that a former executive told the defendants that cost-cutting measures could impede revenue. The Fourth Circuit found that the defendants were never alleged to have agreed with the former executive and therefore this could be chalked up to a simple disagreement among executives, negating any inference of scienter. Significantly, the Fourth Circuit’s analysis makes clear that for plaintiffs to effectively plead scienter, they must allege that not only were defendants aware of concerns that their statements to investors were false, but also that they agreed with those concerns.

The Fourth Circuit’s discussion of stock sales by the defendants should similarly raise concern for plaintiffs who are filing a securities fraud action. In its opinion, the Fourth Circuit found that while one defendant sold 77% of his stock during the class period, he also sold more stock before the class period. Thus, according to the Fourth Circuit, despite the massive amount of stock sold during the class period, if a defendant sells less stock during the class period than before it, scienter is unlikely to be found. Concerning the other defendant, while he sold no stock before the class period, the Fourth Circuit found that he only sold 17% of his stock (amounting to approximately $10 million) during the class period, which was de minimis. The Appellate Court also noted that the plaintiffs failed to explain why the defendant selling 17% of his holdings was not de minimis. Thus, due to the plaintiffs’ failure to address the de minimis issue in their briefing, a defendant’s sale of 17% or less of stock during a class period is unlikely to raise the spectrum of scienter.

Even more concerning for potential plaintiffs was the Fourth Circuit’s notice of the defendants’ 10b5-1 trading plans in its analysis. While the Fourth Circuit recognized that the record is silent about when the defendants entered the plans (and thus cannot say whether the plans mitigate a suggestion of motive) and that 10b5-1 trading plans are effectively affirmative defenses that should not be considered at the motion to dismiss stage, the Appellate Court still considered them in its analysis of the defendants’ stock sales and held that the plans “weaken[s] any inference of fraudulent purpose.” Thus, despite itself acknowledging that there is no evidence to show that the defendants entered into the trading plans after the class period began or that it should not be considering the trading plans at all on a motion to dismiss, the Fourth Circuit still used them to discount any inference of scienter from the defendants’ stock sales. The holding of the Fourth Circuit warns potential plaintiffs that they must carefully examine the stock sales of defendants before and during the class period, as well as thoroughly attack any use by defendants of 10b5-1 trading plans to weaken an inference of scienter.

Finally, the Fourth Circuit considered the temporal proximity between the defendants’ allegedly false statements and the subsequent disclosure of truth and found that while the three-month gap between the rosy picture painted by the defendants and the truth of falling revenue was relevant, it alone could not establish a strong inference of scienter. Ultimately, after discounting most of the plaintiffs’ allegations of scienter, the Fourth Circuit held that, under a holistic analysis, the non-fraudulent inference was more compelling than the requisite inference that the defendants knowingly or recklessly misled investors about the company’s financial health.

While the full implications of the Fourth Circuit’s opinion are yet to be seen, the opinion outlines a difficult road ahead for plaintiffs trying to plead scienter. Moving forward, plaintiffs would be wise to learn from the failings of the DXC plaintiffs and plead their complaints with the particularity and detail that the Fourth Circuit found lacking, address both a defendant’s stock sales and any 10b5-1 trading plans – irrespective of whether they should be considered on a motion to dismiss, and work to find evidence that a defendant not only heard evidence that their statements were misleading, but agreed with that evidence.

Q&A - Christine Simmons

Chief Operating Officer, Academy of Motion Pictures Arts and Sciences

POMERANTZ MONITOR | MAY JUNE 2022

Partner Jennifer Pafiti: You are the first African American and woman to serve as COO for the Academy and you lead its first Office of Representation, Inclusion, and Equity. What do these firsts mean for you and for the motion picture industry?

Christine Simmons: My perspective on firsts has evolved. There always has to be a first. But now I ask, “Why has it taken so long?” We have to reflect back on the system, the organization, and the various industries, and really analyze the ‘whys.’ Why is there only one? What can we do systematically to create more opportunities? Until we look at some of the systematic constructs that affirm or even recreate inequities, then we will continue to have them. Vice President Kamala Harris said, “I may be the first woman to hold this office. But I won’t be the last.” If that happens, then that means that we failed. I don’t want to be the best Black COO. I don’t want to be the best female anything. I just want to be the best me, period. The challenge is acknowledging the inequities that exist because it is not an equal race, period. We have a responsibility here in the film and TV business, and in entertainment in general, to make sure that we’re putting forward images that show people that they can break the mold and be so many different things.

JP: What is the next step for the Academy in regard to DEI?

CS: Keep going, go deeper, go farther, go faster. The Academy is turning 95 this year. You can imagine that helping your 95-year-old grandfather evolve and learn new things is quite the challenge, right? So, from year zero to #OscarsSoWhite, the runway keeps getting shorter, and the need to make change is getting more urgent. Little bite-sized changes are no longer enough. But we can’t just blow up the system. Some of it is good, so let’s figure out how we can break those institutionalized constructs that have continued to reaffirm inequity. After #OscarsSoWhite, our goal was to double the number of women and double the number of people who identify in historically underutilized ethnic or racial communities by 2020. We met and exceeded those goals, in addition to adding some board seats. The challenge with diversity is, if you’re only counting numbers, it doesn’t help people understand the “why.” And if you don’t have the common language and vocabulary and understanding of ideologies that create inequities, you look at it as an attack. We want to make sure that all of our allies are coming along with us to help understand that diversity actually enhances the art form. A big step is the launch of our inclusion standards around Best Picture: If you are interested in submitting your film for Best Picture, then you will need to meet two of four diversity standards. We want to make sure that it’s not limiting or censoring in any way. Our initiative is to broaden the aperture through which excellence is recognized. Because if you’re only looking at your aperture in one place, then you’re missing all this beautiful excellence everywhere else. We’re also looking at supplier diversity, our marketing spend, and our investment portfolio. Our investment committee has directed significant dollars to diverse portfolio managers, which I’m extremely proud of. And those are just some of the behind-the-scenes actions that folks aren’t even aware of, but we know that the ripple effect helps.

JP: What mistakes do even well-intentioned companies make in their diversity plans?

CS: One of my dear friends was chair of OB-GYN at a major hospital. The hospital kept setting meetings at the exact time she had to drop her kids off at school in the morning. Her experience as a working mother was not being heard. That’s why it’s important to have different perspectives on the female-lived experience or the Latino-lived experience in that case because there are aspects of that lived experience that you could study in a book or see on TV, but without living it, you can’t fully understand and account for it in the way you manage your staff. Wanting the numbers, wanting it reflective of the population is beautiful, we love that. But if you don’t create a community, a village, and a safe space where people can feel heard and valued, then it actually sometimes can be worse than if you didn’t bring them in at all. If you feel like you’re constantly demeaned or you’re constantly pushed aside or you’re mansplained, then the numbers don’t matter. There’s a whole revolution happening in corporate culture right now in which, if you don’t have an empathetic ear, if you’re not a servant leader, you’ll find your people joining the Great Resignation. Leaders need to pause for a second to figure what’s going on in this person’s life. And that way, they can hopefully find ways to inspire and motivate and empower their people. When that happens, the organization is always better off.

JP: If an organization takes just one step toward diversity, what should that be?

CS: I would start with education. We all have to understand each other and have a common language. It really starts with ideologies and understanding the difference between ideological oppression, institutionalized oppression, internalized oppression, and interpersonal oppression. People tend to think things are the way they are because that’s just how it always was. Well, there’s a reason why it was that way. Our unconscious bias trainer tells a story about a fish just swimming in the water, not even knowing that the water exists because that’s its life. In that way, a lot of the sexist, racist, and other negative ideologies are just water that’s around us and we don’t even realize it, because we’ve just been in it our whole lives. Stopping the automaticity of the ideologies that we have been swimming in is important for helping people understand. When you think of a CEO, people think of white men. When people think about a convict, they think of black or Latino men, right? They don’t think of maybe an affluent white-collar criminal, and we know some notable ones! Ideologies, education, and building a common vocabulary, start there. Then start looking at the systems.

JP: Can you foresee a time when DEI programs won’t be necessary?

CS: No. But I’m a hopeless idealist and optimist, so I think the beauty is, and my hope and prayer is, that eventually, it goes from fixing the systems to getting to celebrate diversity. What does that look like? I’m about to march in my first Pride Parade, walking next to my brothers and sisters in the LGBTQ community, and we’re going to have a great time. I’m going to celebrate them in their life and in their love. Even though I’m not a member of that community, I get to celebrate them. For me, that’s what it looks like. In regards to racism, folks often talk about being colorblind. Colorblind is beautiful, in its ideology and in theory, but when you turn a blind eye to something, then you make it invisible. We don’t want to make anything invisible; we want to celebrate it.

JP: You have said that you like to inspire people to be their best selves. What is the most effective way to do that?

CS: It starts with just being present and listening. People want to be seen, first and foremost, they want to know that you’re present, that you’re listening, that you care. So, to actually be there is important. And, more importantly, I want everyone to feel as joyful as I feel, as beautiful as I may feel in that moment. And I truly mean it from the inside. Like, that self-love and joy from the inside that makes someone glow. I like to pull that out of people. I want to listen to what they want to do, and then help push them forward and help them live their dreams. Just one conversation can literally change someone’s life because they may not know what type of career they want. That conversation may expose them to a whole other world – a job or a path or a choice that they never knew existed.

JP: You are a volunteer for Brown Girls Dream. What advice do you give to young leaders of color?   CS: One of my besties, Cari Champion, a broadcaster, producer and phenomenal woman, tapped into all of her besties in the entertainment and sports businesses, like Jemele Hill (The Atlantic Contributor and Host of Unbothered), Bozoma Saint John (Hall of Fame Marketing Exec), Nischelle Turner (5x Emmy-winning host of Entertainment tonight and a Producer) and myself, to mentor young 20-somethings who aspire to similar careers. And it’s been great. I get three to four mentees a year. They come to us for career advice and guidance. What I’m loving most is seeing the network they’re creating amongst themselves. What we do is really a level beyond mentorship – it is sponsorship because we have actually hired many of the extraordinary women within our various organizations. We’re removing many of the roadblocks that we had to face so they can get here faster, with less pain, drama, and trauma, so they can make an even bigger impact. One of the hardest lessons that young leaders and executives have to learn is that as you go up, as you become more successful, we have to solve multiple people’s problems and multiple organizational problems. And so, we help them navigate all of that to show them the different perspectives through our lived experiences.

JP: From YMCA Visionary to Ebony’s Power 100 list and being touted as one of LA’s most influential people, you have received many accolades. Is there one accomplishment that makes you proudest?

CS: Honestly, all of those make me really proud. But there was a time, around the time Hillary was running for president – it was actually the night before – and I was watching and very stressed. My son was like, “Mom, what’s wrong?” He was five or six at the time, and I had started working at Sparks when he was about three. So, I told him that tomorrow we might have our first female president. Now, mind you, I’m a single mom, so I had been taking him with me to the games and to board meetings of the UCLA Alumni Association when I was president. And he would just sit in the corner at all of the work events and watch. So, he said, “But Mom, you’re a president.” And in that moment, first – I had tears. Second – it was mom for the win, right? Because there was so much guilt with sometimes having to parent in front of 10,000 fans at Staples Center because I needed to bring him with me. There was guilt when I saw my boss and I had my son on my hip. Then I thought – Look, you run this organization, Christine, you have to set the tone. You have to tell people, it’s okay. I just had to shift my mentality and not worry about that. Moms know how mom guilt works – you have a late meeting and they’re asking “Mom, are you coming home?” but you can’t be there all the time. They don’t mean to make you feel bad, but they just miss you. So, when he said that, I thought – exposure works! One of the things that I think as a society, we don’t do enough, is expose. He’s been exposed to women presidents in all areas of life, so why wouldn’t one be President of the United States, right? I think it’s that if we expose young men and young girls to all of this more often, then we’ll be in a much better place. So, for me, yes, those awards are phenomenal and they’re affirming but I think more about the impact that we’re making for the next generation. And, that night, that did it for me. So that’s most important.

SPAC Attack: How Pomerantz and the SEC Are Tackling SPAC Liability

POMERANTZ MONITOR | MAY JUNE 2022

By James M. LoPiano

By now, many investors are aware of that recently trending phenomenon, the Special Purpose Acquisition Company, or “SPAC” for short. However, investors may confuse going public via “de-SPAC” transactions, whereby a SPAC takes a private company public, as equivalent to traditional initial public offerings, or “IPOs.” Others may be unaware that SPACs first conduct their own IPO before taking other companies public.

IPOs and de-SPAC transactions are subject to very different rules, and holding SPACs, and companies formed by de-SPAC transactions (“de-SPAC companies”), accountable in connection with IPOs and de-SPAC transactions may prove more complicated than holding other companies accountable in connection with IPOs. Recognizing this, both Pomerantz and the SEC have been formulating their own ways to harmonize SPAC-related liabilities with traditional IPO liabilities.

Most investors are familiar with the idea of a “traditional” IPO, whereby a private company, supported by underwriters, satisfies certain conditions to begin publicly trading on a national securities exchange at a pre-determined initial offering price. For example, take a hypothetical private company called “XYZ Corp.” that conducts an IPO and thereby first begins publicly offering its shares to the public under the ticker symbol “XYZ” at an IPO price of $10 per share.

Recently, however, private companies have increasingly gone public through business combinations with SPACs, also called “blank-check companies,” which are development stage companies that have no operations of their own, apart from looking for private entities with which to engage in a merger or acquisition (called “target” companies) to take the target public. The SPAC has already gone public via its own IPO in this scenario and, indeed, a SPAC usually touts its management’s ability to identify and merge with potentially lucrative targets in the registration statement for its IPO.

So, what does a de-SPAC transaction look like? Let’s assume a hypothetical SPAC called “ABC Company” recently went public via an IPO. Individuals invested in ABC Company’s IPO on the understanding that its management have expertise in identifying targets and conducting due diligence in selecting and closing mergers with those targets. ABC Company then identifies several targets looking to go public, including our hypothetical XYZ Corp., and agrees to take XYZ Corp. public. ABC Company then merges with XYZ Corp. and, in the process of doing so, changes its name and business operations to XYZ Corp.’s name and business operations (or something similar), issues new shares under a new ticker symbol reflecting its new identity (for example, converts “ABC” shares to “XYZ” shares), and some or all of XYZ Corp.’s management starts running the newly combined company. In our hypothetical, XYZ Corp. has essentially “gone public” through the already-public ABC Company’s transformation into, essentially, what was XYZ Corp.

In this way, SPACs are like shapeshifters or doppelgangers; they are publicly listed blank slates waiting to take on the persona, business operations, and executive teams of private companies. However, these de-SPAC transactions present their own issues that individuals may be unaware of when investing in the post-merger de-SPAC company or pre-merger SPAC.

When individuals lose money on their investments in IPOs, they may seek relief under the federal securities laws through a strict liability claim under Section 11 of the Securities Act of 1933. Under Section 11, public companies can be held strictly liable in connection with material misstatements or omissions made in the IPO’s registration statement—which is required to register new shares and conduct the IPO—so long as the Section 11 claim is brought within a time limit set by the law. When investors purchase shares pursuant or traceable to an IPO’s registration statement, they typically show a loss on their investment for Section 11 purposes by comparing the share’s IPO price to its current trading price.

In the context of a SPAC IPO or de-SPAC transaction, however, it can be difficult to identify whether the original security is trading below its initially offered price. Why? The answer depends on whether you are bringing a Section 11 claim based on the SPAC’s IPO, or the de-SPAC transaction.

Shares offered in a SPAC’s IPO, usually called units, typically become stock and warrants that eventually list under different ticker symbols at different prices. Additionally, the SPAC’s securities (unit, stock, warrant, or otherwise) will typically convert into shares of the de-SPAC company following the de-SPAC transaction. Under both scenarios, shares purchased pursuant or traceable to the SPAC’s IPO may not be listed anymore, so it becomes difficult to know what their current market value is and to compare that value to the IPO price for purposes of Section 11.

De-SPAC transactions present their own issues simply because, unlike IPOs, they often do not have an IPO price or other formally, predetermined, easy to identify initial trading value to compare to current market values.

In bringing SPAC cases to the courthouse, Pomerantz has formulated several potential solutions to these problems. For example, if an investor wants to bring a Section 11 lawsuit in connection with shares purchased in a SPAC’s IPO (let us say they are units), and the units no longer trade, so there is no current unit price to compare to the IPO price, you might allege liability by seeing whether whatever the units transformed into—stock, warrants, or otherwise—are trading so far below the unit’s IPO as to be reasonably certain that you lost money on your investment.

On the other hand, if an investor wants to bring a Section 11 lawsuit in connection with shares purchased in a de-SPAC transaction, and they see that the shares purchased in the de-SPAC transaction are trading low, but there is no IPO price, per se, to compare it to, the investor might allege liability by substituting a formal IPO price for the de-SPAC company’s first publicly listed closing price.

Moving beyond strict liability claims under Section 11 of the Securities Act, an investor may opt to allege securities fraud claims under Section 10(b) of the Securities Exchange Act of 1934. Although more difficult to allege, in this scenario an investor might argue that the SPAC and its management knowingly overstated their expertise and due diligence efforts in identifying and acquiring a target company. Alternatively, investors might argue that the target company and its management knowingly hid issues from the SPAC or the public when announcing it would go public via a de-SPAC transaction.

Additionally, somewhat like a Section 11 claim under the Securities Act, there is a Section 14(a) claim under the Exchange Act, which investors can bring in connection with material misstatements or omissions made in a merger’s registration statement. Here, too, there may not be a formal IPO or other predetermined listing price for new shares created in a merger for a de-SPAC transaction, so one might compare the de-SPAC company’s current trading price to its first publicly listed closing price to allege liability.

The SEC, on the other hand, has proposed sweeping rule changes for SPACs that, if adopted, could better align de-SPAC transaction liability with traditional IPO liability. As noted by The National Law Review, these proposed rule changes cover six broad areas: (1) specialized SPAC disclosure requirements; (2) aligning de-SPAC transactions with traditional IPOs; (3) business combinations involving shell companies; (4) increased projections disclosures; (5) Investment Company Act safe harbor for SPACs; and (6) fairness of the de-SPAC transaction.

One such rule could effectively end protections afforded to companies under the Private Securities Litigation Reform Act of 1995 (“PSLRA”) when making forward-looking statements accompanied by meaningful cautionary language in connection with de-SPAC transactions. These safe harbor protections essentially boil down to companies and management disclaiming liability for positive statements made about potential future projections, earnings, results, plans, etc. (hence, “forward-looking” statements) when paired with adequate warnings about the certainty of these events occurring. Companies provide safe harbor warnings in many contexts, including earnings releases, quarterly reports, and even investor calls. The SEC’s proposed rule changes would modify the definition of a “blank check company” for the purposes of the PSLRA to include SPACs, and the PSLRA bars such safe harbor from applying to forward-looking statements made in connection with traditional IPOs or securities offerings by blank check companies.

Another example of rules aimed at harmonizing de-SPAC transaction liability with IPO liability includes a proposal that would amend registration statements issued in connection with de-SPAC transactions. Under this rule change, the target company would have to sign as a co-registrant on the registration form filed by the SPAC for the de-SPAC transaction. Additional signatories could include the target company’s principal executive officer, principal financial officer, controller/principal accounting officer, and board members, who could then be held strictly liable under Section 11 of the Securities Act for any material misstatements or omissions in the registration statement.

As stated by SEC Chair Gary Gensler, “Functionally, the SPAC target IPO is being used as an alternative means to conduct an IPO. Thus, investors deserve the protections they receive from traditional IPOs, with respect to information asymmetries, fraud, and conflicts, and when it comes to disclosure, marketing practices, gatekeepers, and issuers.”

Although Pomerantz and the SEC are using different government branches to tackle these issues—for Pomerantz, the courthouses of the judicial branch, and for the SEC, the rule-making process of the executive branch—both are working to harmonize SPAC-related liabilities with traditional IPO liabilities. All the same, investors should avoid confusing IPOs with de-SPAC transactions and remain aware of the foregoing issues when deciding to invest in either SPAC IPOs or de-SPAC transactions.

Free Speech vs Corporate Lies: The Role of the First Amendment in Securities Fraud

POMERANTZ MONITOR | MARCH APRIL 2022

By Villi Shteyn

The intersection of fraud and claimed free speech protection under the First Amendment is fraught with controversy. From defamation to fraud, obscenity, hate speech, and even fighting words – the fine line between protected and prohibited speech is left largely undefined by guidelines from the bench that sometimes fail to go beyond “you’ll know it when you see it.” Add commercial speech and the complexities of securities fraud class action litigation into the debate and you have what James C. Goodale – famed General Counsel who represented The New York Times in their Sullivan and Pentagon Papers cases – described as a “collision course” between the First Amendment and securities regulation. Goodale asserted that “there is no greater statutory regulation of speech than the ‘33 and ‘34 Securities Acts and the ‘40 Investment Adviser and Investment Company Acts.”

A recent case involving oil giant ExxonMobil Corp. (“Exxon”) shows how bad faith misuse of the First Amendment can threaten investor protections. In a recent appeal in Massachusetts state court, Exxon argued that Massachusetts Attorney General Maura Healey’s suit under the state’s consumer protection statute should fail because Exxon’s public statements (and alleged omissions) relating to climate change were protected under the First Amendment of the United States Constitution. Exxon claimed the statements, rather than being targeted at consumers and investors, were directed at policymakers and the public at large to influence energy policy, thus fitting into the statutory definition of “petitioning.” Exxon argued that, due to its position as a large energy company, it must take an active role in the public discussion on energy policy, and these statements are protected so that it can fulfill that role.

Suffolk Superior Court Justice Karen Green did not find Exxon’s arguments convincing and denied dismissal of the suit. Justice Green found that Attorney General Healey’s claims that Exxon lied to consumers by marketing its products as environmentally friendly could move forward, as could claims that Exxon misled investors by downplaying any climate-driven financial risks to its bottom-line financials. Significantly, Justice Green found that commercial speech is protected under the First Amendment if the speech concerns lawful activity and is not misleading, but not when it includes fraudulent statements. Given the allegation of fraud to consumers and investors, she held that First Amendment protection was not warranted at the motion to dismiss stage.

On appeal, Exxon has argued that “[b]y premising its claims on Exxon’s advocacy and alleged omissions regarding preferred policies on climate change, the Commonwealth seeks to curtail Exxon’s exercise of its right of petition by punishing Exxon, through litigation, for not propounding a particular message.” Exxon further claims that climate change is one of several controversial and sensitive topics of public concern, and due to that, forcing any disclaimers to accompany Exxon’s statements regarding the matter to prevent allegedly misleading omissions is compelled speech on issues of public concern, and an unconstitutional step by the Commonwealth of Massachusetts to take. It further argues that this is simply “a policy disagreement about the potential scale and efficacy” of certain alternative energy sources. Exxon also claims that the Commonwealth’s views on what constitutes good or poor energy policy should not form the basis of forcing the company to disseminate opposing viewpoints on the matter or otherwise subject itself to liability. This, according to Exxon, creates a chilling effect on petitioning activity vis à vis the First Amendment.

The Massachusetts Attorney General responded that the intended audience was very clearly investors and consumers; Exxon’s statements were commercially motivated and profit-oriented, rather than petitioning the government. Exxon’s claims of petitioning, according to the AG, are a phony pretext for its actual goal for the statements, and its First Amendment defense is a delay tactic used by defendants in similar cases. Additionally, the Commonwealth of Massachusetts had the clear goal of protecting investors and consumers, not punishing Exxon due to disagreements with its climate change policy viewpoints.

Some examples of representations clearly made to investors were that Exxon will “face virtually no meaningful transition risks from climate change.” In Exxon’s 2018 Energy Outlook, the company told investors that it “use[s] the Outlook to help inform ... long-term business strategies and investment plans.” According to the AG, these statements plainly target investors and should not be shielded from liability under the contrived premise of free speech. The Commonwealth further pointed to the fact that Exxon itself described their communications as “branding and marketing efforts,” “corporate messaging,” and “statements highlighting the positive features of its business.” Plainly, the Commonwealth argues, they aim to deceive investors about the significant and existential threat that climate change poses to the company’s value. The appeal is currently pending in the Massachusetts Supreme Court.

Exxon’s line of reasoning certainly raises concerns in the context of securities fraud actions, although, in a good sign to investors, courts have been similarly unconvinced in that context in several recent cases. One example is in a recent major victory for Pomerantz in the Altria and JUUL securities fraud litigation in the Eastern District of Virginia. The court there, in a 2021 opinion, found that the Noerr-Pennington doctrine, which is meant to safeguard the First Amendment right to petition the government for a redress of grievances by immunizing liability that may attend the exercise of that right, did not call for the dismissal of plaintiffs’ claims related to defendants’ statements made to Congress – in this case, Altria and Juul’s denials that they marketed their nicotine vaping products to children – because “the First Amendment offers no protection when petitioning activity ... is a mere sham to cover an attempt to violate federal law.” The court found that plaintiffs’ fraud allegations under the Exchange Act raised the sham exception, and, in any event, the doctrine was an affirmative defense that could not be decided at the motion to dismiss stage. Thus, even if speech was established as petitioning, First Amendment protection does not apply when the speech is used to fraudulently deceive investors.

A 2020 Northern District of California court opinion found similarly against Apple in a securities fraud action against the company concerning allegations that processing performance was intentionally throttled on iPhones. In this case, the court denied the Noerr-Pennington First Amendment defense because Apple could not show that it was seeking any redress from policymakers implicating their First Amendment rights, despite the speech in question being a letter to Congress.

In 2003, in Nike, Inc. v. Kasky, the argument for First Amendment protection for corporate speech reached the United States Supreme Court, as Nike fought allegations of false advertising by claiming that their denials of engaging in unfair labor practices and subjecting workers to unsafe working conditions were actually protected speech related to matters of public concern. Nike initially prevailed at trial and in the California Court of Appeals but lost on reversal in California Supreme Court – sending it to the High Court. While the U.S. Supreme Court accepted the case, they eventually sent it back down as “improvidently granted” – meaning they should not have accepted it in the first place – although Justice John Paul Stevens noted that the case presented “novel First Amendment questions because the speech at issue represents a blending of commercial speech and debate on issues of public importance.” Unfortunately, the case was settled before the issues at hand could be resolved with further clarification of just how free corporate speech can be on matters of public interest.

Despite some limited protection in narrow circumstances, there is strong judicial backing of the principle that companies cannot hide behind perceived First Amended rights to lie to or mislead investors. Some courts have found that outlining the factual basis for an opinion leads to First Amendment protection; however, Circuit Courts of Appeals have generally found that punishing securities fraud does not violate the First Amendment and laws punishing fraudulent speech survive constitutional scrutiny even when applied to pure, fully protected speech. In fact, in 2009, the Fourth Circuit explicitly found that “Punishing fraud, whether it be common law fraud or securities fraud, simply does not violate the First Amendment.” The Supreme Court has also stated, as cited by Suffolk Superior Court Justice Karen Green in Exxon: “the First Amendment does not shield fraud.”

It is well-settled law that the First Amendment does not protect fraud, and so courts are unlikely to prevent investors from enforcing their rights to be protected from false and misleading statements under the guise of free speech. Securities fraud defendants will certainly continue to use the tactic of improperly hiding behind the First Amendment to shield themselves from liability for false or misleading statements. However, they should be wary -- especially in the age when outspoken corporate officers can find themselves just one tweet away from destroying shareholder value with misguided, misleading, and potentially fraudulent comments.

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.